Material adverse change (MAC) clauses: acquisitions

Practical Law UK Practice Note w-034-8163 (Approx. 15 pages)

Material adverse change (MAC) clauses: acquisitions

by Practical Law Corporate

About this note

In many share or business sale and purchase transactions, the acquisition agreement is signed and completed simultaneously. This completion model tends to be the preferred approach in practice, both for its simplicity and execution certainty. However, a simultaneous exchange and completion is not always possible for various legal or commercial reasons. Instead, there is a gap between signing the acquisition agreement and completing the transaction, often to allow certain conditions precedent to be satisfied, such as obtaining regulatory approval or shareholder consent for the transaction.

Having a split exchange and completion adds a further layer of complexity to the transaction process as (among other things), the parties must consider the allocation of financial and other risks relating to the target company or business in the interval between exchange and completion.

A possible mechanism for addressing risk allocation during the pre-completion period is a material adverse change (MAC) or material adverse effect (MAE) clause (both of which are referred to in this note as a MAC clause) which aims to give the buyer a right to walk away from the transaction before completion if events occur following exchange that are detrimental to the target company or business.

This note explores the use of MAC clauses in private M&A transactions in the UK, including:

When and why MAC clauses are sought (see What is a MAC clause and when are they used?).
The form and content of a typical MAC clause (see Format of MAC clauses) and the key points for negotiation (see Drafting and negotiating MAC clauses).
Judicial consideration of the interpretation and application of MAC clauses (see English courts' approach to interpreting MAC clauses).

Except where otherwise stated, the considerations highlighted in this note are of equal application to both share and business purchases. A reference to the target in this note therefore includes, in the former case, the target company and, in the latter case, the business that is being sold. References to the target also include, where the context requires, the seller of the assets comprising the business that is being sold. References to the target business are, on a share purchase, to the target company's business and, on an asset purchase, to the business that is being sold.

For general information on share and asset purchase transactions, see Practice notes, Share purchases: overview and Asset purchases: overview. For guidance on general issues arising in transactions involving a split exchange and completion, see Practice notes:

What is a MAC clause and when are they used?

In an acquisition context, a MAC clause is a contractual mechanism that seeks to allow the buyer to terminate the acquisition agreement and withdraw from the transaction if, before completion, certain events occur that have a significant, detrimental effect on the target's business, assets or profits. This means that a MAC clause is usually only relevant in a private M&A context where there is a gap between exchanging the acquisition agreement and completion of the transaction.

A MAC clause is essentially a tool for allocating pre-completion risk between the parties and has the effect of transferring from buyer to seller the risk of adverse events occurring between signing and completion. Relevant pre-completion adverse change risks include:

Increases in raw material, commodities, labour or other costs.
Shifts in customer demand, loss of key suppliers or other supply chain disruption.
Emergence of competitive products or services.
Changes in financial markets, interest rates, currency exchange rates, unemployment levels or other macroeconomic conditions.
Changes in law.
Force majeure events, such as natural disasters, war, terrorism, pandemics or other civil or public health emergencies.

While MAC clauses have been market-standard in US acquisition agreements for many years, they have not historically been a common feature of private acquisition agreements in the UK (see Practice note, US and UK share purchase agreements: comparing approaches: Material adverse change and Article, Private M&A across Europe: past, present and future: MAC clauses, PLC Magazine, 2018).

However, periods of economic uncertainty, market disruption and price volatility often lead to a spike in buyers seeking to introduce additional conditionality or termination rights in the acquisition agreement, including through MAC clauses, to give them contractual flexibility to walk away from the deal (or provide leverage to renegotiate terms) if there is a downturn in the target's fortunes between signing and completion.

Whether or not a buyer is successful in securing the benefit of a MAC clause will depend on the circumstances of the transaction, and can be influenced by a range of factors such as:

The strength of the parties' respective negotiating positions which, in turn, may be influenced by which party is responsible for the delay between exchange and completion.
The length of the anticipated gap between exchange and completion; the lengthier the delay, the keener buyers will be to secure some sort of MAC protection.
The nature of the target business.
The prevailing economic and market conditions.
Whether the buyer is relying on externally provided finance, in which case a MAC condition may be required to match its finance terms.

Challenges in invoking MAC clauses

Buyers should bear in mind that even if they are successful in negotiating the benefit of a MAC clause, it does not necessarily provide a panacea for all ills, and seeking to invoke the clause to terminate the acquisition agreement may itself involve risk.

A buyer seeking to justify the termination of an acquisition agreement on the basis of a MAC clause has the generally high burden of proving that a MAC has occurred within the meaning of the provision. What this entails very much depends on the precise language of the agreement concerned including, in particular, how (and if) it defines what constitutes a MAC.

Whether or not a MAC has occurred is generally a factual determination, with no legal certainty for the party seeking to rely on the provision; each clause turns on its own wording and the context of the agreement in which it appears. Moreover, English courts have interpreted MAC clauses on only a handful of occasions, meaning there is a shortage of judicial precedent as to the likely approach (for further information, see English courts' approach to interpreting MAC clauses).

If the buyer's assessment that a MAC has occurred is wrong, and it terminates the acquisition agreement by invoking a MAC clause when it is not entitled to do so, it risks incurring liability to the seller for repudiatory breach of contract (for general information on this issue, see Practice note, Contracts: termination: Getting termination wrong).

MAC clause as re-negotiation tool

Despite the potential challenges in establishing whether a MAC clause is engaged in a given scenario, they may nevertheless provide the buyer with the necessary leverage to force the re-opening of discussions around price, or to obtain concessions on other key deal terms.

Sellers will be mindful that litigation involving the interpretation of MAC clauses is an uncertain proposition and may therefore be persuaded to renegotiate terms before completion to avoid both the time, expense and uncertainty involved in pursuing a breach of contract claim against the buyer, as well as the difficulties associated with trying to put the target back on the market (possibly at a lower price).

A MAC clause can therefore operate as a powerful renegotiation tool where there is a significant deterioration in the target business or the target's financial position between signing and completion.

Format of MAC clauses

MAC clauses in acquisition agreements generally take one of two forms:

A condition precedent to completion which entitles the buyer to refuse to complete the transaction if the target suffers a MAC between the exchange date and completion.
A warranty from the seller that the target has not suffered a MAC between a specified date and completion, coupled with a completion condition that entitles the buyer to terminate if that warranty is not true at completion.

For precedent MAC clauses drafted for use in a corporate acquisition agreement, see Standard document, Material adverse change clause: asset purchase agreement and Standard clause, Material adverse change clause: share purchase agreement.

Drafting and negotiating MAC clauses

MAC clauses typically allocate risks that neither party can comfortably quantify or control between exchange and completion, and so they are usually heavily negotiated as a result.

Defining a MAC

How the acquisition agreement defines what constitutes a MAC, and in particular, what will be regarded as "material" for the purposes of the clause, is a key consideration, as this ultimately drives whether the buyer has the requisite grounds to invoke the associated termination right.

However, there is a tendency in UK practice to keep the drafting of this type of provision quite general, and to not expressly define what constitutes a MAC. Instead, the clause typically includes a high-level description of a MAC (for example, "…any fact, matter, event, circumstance, condition or change which materially and adversely affects the business, operations, assets, liabilities, condition of the target…"), which is then subject to list of express carve-outs that the parties agree do not constitute a MAC.

It is also not uncommon for drafters to shy away from expressly defining "material", or specifying how materiality should be measured (for example, by reference to a reduction in EBITDA). This approach is reflective of the fact that it can be extremely challenging for the parties to reach agreement during the transaction negotiations on the parameters of materiality by reference to quantitative thresholds (for example, by reference to a monetary amount or percentage drop in the relevant measure).

In addition, giving examples in the acquisition agreement of what constitutes a MAC raises the risk for the buyer that anything short of these examples will fall outside the scope of the provision. It may therefore be concluded that the preferable approach (or the lesser evil) is to forego defining "material adverse change" with any specificity, and instead leave the matter to the courts to resolve should a dispute arise as to whether the clause is engaged, against the backdrop of the particular facts. It is also arguable that a degree of ambiguity preserves an incentive for the parties to resolve the issue through renegotiation if it is alleged that a MAC has occurred, rather than go to the expense and uncertainty of litigation.

MAC carve-outs

A typical MAC clause incorporates a number of seller-friendly carve-outs in respect of matters that will neither constitute a MAC, nor be considered in determining whether a MAC has occurred. While the nature and extent of any applicable carve-outs will vary from transaction to transaction, sellers often argue that the buyer should not be able to withdraw from the transaction if the target suffers a material adverse change due to:

The same macroeconomic, industry wide, force majeure or otherwise generally applicable risks that the buyer already faces in its own business, and which it is therefore equally capable of evaluating and bearing in relation to the acquisition.
Risks inherent in announcing and effecting the transaction or otherwise arising out of the buyer's actions.
Risks that the buyer has agreed to assume by reason of accepting their disclosure in the disclosure letter.

Buyers, in turn, typically negotiate the disapplication of these seller-friendly carve-outs for changes or conditions that adversely affect either the target or its industry in a disproportionate manner relative to other businesses in same industry, or to other industries (as the case may be).

Key drafting considerations for buyers

Careful drafting is required to maximise buyer certainty that a MAC clause can be relied upon to withdraw from a transaction. The key drafting considerations when acting for a buyer include:

General or specific trigger. The buyer should consider whether it requires a general MAC clause that is triggered by any event, circumstance or occurrence that has a material negative impact on the target, or whether the MAC clause should be limited to a specific type of event or risk. While buyers are likely to favour a generally drafted MAC provision, that seeks to maximise the range of circumstances in which the clause may be invoked, this approach can be subject to uncertainty as to whether a particular event or risk is within the scope of the clause. Where a buyer has in mind protecting itself from the consequences of a specific event or risk, it may be preferable to address this in a separate condition, rather than seeking to rely on a general MAC clause (for further information, see Specific completion conditions).
Objective criteria. Certainty around the buyer's ability to invoke a MAC clause may be improved by including specific, objective tests for determining whether a MAC has occurred. If a particular risk or metric might materially affect the buyer's economic assessment of the target, for example, EBITDA, revenue, cash flow, material customers or material contracts, the buyer should consider incorporating an objective measure of this item into the MAC clause, taking care to preserve the generality of its application otherwise. For example, if the target company has a volatile turnover, the MAC clause could specify the threshold at which a fall in turnover becomes a MAC. However, while adding objective criteria provides buyers with a clear test for walking away from the deal, and delivers greater certainty for the parties, this approach could have the effect of narrowing the circumstances in which the clause can be invoked. The buyer will therefore need to be confident that it has a thorough understanding of the nature and extent of the likely impact on the target of the particular risks the buyer intends the MAC clause to cover. The buyer should also be mindful that where the clause is aimed at addressing risk factors that are in a rapid and unpredictable state of flux, an objective MAC provision which seems appropriate when the acquisition agreement is signed may, with hindsight, be inadequate to capture the effects on the target in both the short and medium term. Objective criteria can also have the negative effect of shifting management focus in the operation of the target business to monitoring and keeping within the specified criteria, which could have an adverse effect on the target's long-term prospects.
Subjective standards. Buyers may consider trying to negotiate a subjective standard (for example: "…in the reasonable opinion of the buyer there has been a material adverse change…") under which the existence of MAC falls to be determined by reference to the buyer's opinion or belief, rather than on the basis of an objective standard. However, as a subjective standard puts the buyer in a very strong position by substantially lowering the bar for invoking a MAC clause (the buyer simply needs to have formed the requisite opinion that a MAC has occurred), this approach is likely to be met with robust opposition by sellers. Buyers should also be mindful that where a subjective standard applies, they may nevertheless be required to demonstrate to the court that they formed the requisite view that a MAC has occurred acting honestly and rationally. For further information on judicial consideration of a subjective MAC clause, see Cukurova Finance: subjective MAC clauses.
Duration of the adverse event. Unless the acquisition agreement states otherwise, in assessing whether a MAC has occurred, it appears that the court will require a long-term adverse impact on the target's position (Grupo Hotelero Urvasco v Carey Value Added SL and Another [2013] EWHC (Comm) 1039). A buyer concerned about more short-term fluctuations in fortunes may consider including specific timeframes in the MAC clause with a view to qualifying the requirement for durational significance that will otherwise be imposed.
Existing circumstances. Case law suggests that a party invoking a MAC clause to terminate an agreement will be unable to do so on the basis of circumstances of which it was aware on entering into the agreement, although it may be possible to invoke the clause where conditions worsen in a way that makes them materially different in nature (Grupo Hotelero). This could present challenges to using a MAC clause to protect the buyer against the impact of a known risk (such as the COVID-19 pandemic or the 2022 crisis in Ukraine; see Practice note, Russia sanctions and related considerations: key issues for corporate lawyers), as the trigger event has already occurred. However, with careful drafting, it may be possible to create a termination right that is engaged in the event of a significant deterioration or worsening of the effects of the known risk on the target.
General economic or market changes. If the buyer wishes certain events outside of the seller's control to fall within the scope of the MAC clause (such as a downturn of general economic or industry conditions, the occurrence of another global pandemic, or acts of war, terrorism or civil unrest) these events should be specifically included in the MAC clause. If the seller successfully negotiates general market events as being an exception to what constitutes a MAC (see MAC carve-outs), the buyer should consider adding wording that means the MAC clause can still be triggered if:
- the target is impacted to a significantly greater extent than other companies in its industry; or
- the industry in which the target operates is disproportionately affected when compared to other industries.
However, it should be acknowledged that carve-outs of this nature can be quite uncertain in their application and are likely to require expert industry evidence if they came before the court.

Key drafting considerations for sellers

MAC clauses are not market standard in UK transactions and a domestic seller can typically be expected to strongly resist the inclusion of such a provision in the deal documents, irrespective of prevailing economic conditions or market disruption.

If a MAC clause cannot be avoided, the seller should try to narrow the scope of the provision as far as possible. For example:

Ensure the MAC clause is subject to carve-outs in respect of events or changes that are outside the seller's control and which affect an industry generally (such as changes in general economic, industry or political conditions, changes in financial or securities markets, changes in law or applicable accounting principles, acts of god or other natural disasters, pandemics and acts of war, terrorism or civil unrest).
If the buyer seeks to restrict the scope of the seller's carve-outs by including a disproportionate effects exception, the seller could try to limit the restriction to any material disproportionate impact. The parties may also negotiate the comparison group for the disproportionate effects exception (for example, by limiting it to a specified business type, geographic area or to businesses of a comparable size). The dispute that arose in Travelport Ltd v Wex Inc [2020] EWHC 2670 (Comm) illustrates the importance of careful and precise drafting when building carve outs and disproportionate effect exceptions into a MAC clause. For further information, see Travelport v Wex: MAC clause invoked due to COVID-19 pandemic.
Expressly provide that a MAC only includes events that are expected to have long-term effects to ensure, for example, that a short-term blip in earnings cannot be treated as a MAC for the purposes of the acquisition agreement.
Avoid a forward looking standard. Try to limit the operation of the MAC clause to events which have had, or will definitely have, a material adverse effect. Also resist extending the scope of the provision to include events that lead to a material adverse change in the target's "prospects", as this will involve the difficult and imprecise task of assessing how an event, condition or change will affect future operations or profitability. Including "prospects" may also give the buyer the right to invoke the MAC clause if the target's actual performance falls short of any projections the seller may have provided to the buyer.
On a share sale, if the target company has subsidiaries, the seller should ensure that the MAC provision only captures events that have an impact on the target group as a whole, rather than any one company individually.

Specific completion conditions

Given the difficulties in negotiating, and the potential uncertainties in seeking to rely on, a broadly drafted MAC clause, buyers may have greater success in achieving their desired risk allocation where they instead focus on identifying the main pre-completion risks and issues for the target and build bespoke conditions into the acquisition agreement to specifically reflect those risks. On this approach, unless the specific condition is met, the buyer is under no obligation to complete and will be able to terminate the transaction. Milestone completion conditions of this type could include, for example:

Solvency of the target.
Achievement by the business of specified minimum EBITDA, revenue or other financial target during the pre-completion period.
Absence of the loss of a specified number or percentage of customers or clients.
Achievement of a specified operational milestone event with financial implications.
Retention of key suppliers or employees.

For further information on conditions to completion in a corporate acquisition, see:

English courts' approach to interpreting MAC clauses

MAC clauses in English law-governed contracts are construed in accordance with the usual principles of contractual interpretation. This approach involves the courts giving careful consideration to the language that has been agreed upon, in the context of the wider contract and the facts known to the parties when they entered into it. For general information on contractual interpretation, see Practice note, Contracts: interpretation.

Determining what is meant by the term "material adverse change" and whether the events that the buyer seeks to rely upon fall within its scope are usually the key issues. However, as an acquisition agreement will commonly not define "material adverse change" with any great specificity, its interpretation is typically subject to uncertainty.

Historically, there has been a sparsity of English case law on the interpretation of MAC clauses (for details of some rare examples, see Courts' consideration of MAC clauses in UK acquisition agreements). This could, in part, be driven by the fact that MAC clauses are not a regular feature in private acquisitions in the UK. It may also be reflective of buyers being deterred from seeking to enforce MAC provisions given the highly fact-dependent nature of their interpretation, and the potential difficulties in discharging the burden of proof that a MAC has occurred. Available authority suggests that there is a heavy evidential burden on the party alleging a MAC. This stems from both from public policy that favours the enforcement of signed deals where the commercial risks are discernible by the parties (especially sophisticated and well-advised parties) and reflected in the agreed price, and from the court's awareness that MAC clauses are open to being used opportunistically in cases of buyer's remorse.

In the absence of a substantive body of domestic jurisprudence on the interpretation of MAC clauses, practitioners have looked to case law in other jurisdictions (and the United States in particular) for guidance. There are numerous examples of Delaware court decisions involving MAC clauses, from which some assistance may be drawn. Indeed, in Travelport Ltd v Wex Inc [2020] EWHC 2670 (Comm), in which the Commercial Court was asked to consider a MAC clause in a share purchase agreement, due to the acknowledged "dearth" of other relevant English authority, the court was willing to look at Delaware authority and US academic commentary to assist in its analysis, noting that while those authorities would:

"… obviously not be binding or formally persuasive…to ignore the thinking of the leading forum for the consideration of these clauses, a forum which is both sophisticated and a common law jurisdiction, would plainly be imprudent – as well as discourteous to that court. "

(Travelport, Cockeril J, at paragraph 176.)

For further information on the US approach to interpreting MAC clauses, see box, MAC clauses before the US courts.

Grupo Hotelero: interpreting MAC clauses

The leading English court decision on the interpretation of MAC clauses is Grupo Hotelero Urvasco v Carey Value Added SL and Another [2013] EWHC (Comm) 1039, in which the court considered whether the defendant fund (lender) was entitled to refuse a drawdown request by the claimant Spanish hotel company (borrower) under the terms of their facility agreement on the grounds that the bursting of the Spanish property bubble in 2008 meant that a MAC to the borrower's financial position had taken place. While noting that the proper application of any MAC clause turns on its own terms, Blair J made the following key observations:

The party alleging a MAC bears the burden of proving that a MAC has occurred.
An adverse change must be material and will only be material if it significantly affects a party's ability to perform its obligations under the relevant agreement.
The change must be "significant" to meet the threshold of materiality and will only be material if it significantly affects a party's ability to perform its obligations.
In order to be material, an adverse change must not be temporary in nature. Even if the event giving rise to a MAC is temporary, the MAC it causes must have a lasting impact on the party and its ability to perform under the relevant agreement.
Where the MAC clause is limited to a MAC to a party's "financial condition", this is to be determined primarily by reference to its financial information (such as its interim financial information and management accounts), although the enquiry can extend beyond the financial information to include other evidence, if it is compelling.
Evidence of general external economic or market changes (such as, in that case, the precipitous crash of the Spanish property market and the impact on the construction sector) would not of itself constitute a MAC, as the party at issue may perform better (or worse) than the sector in question.
A MAC must involve a change. Consequently, a party may not invoke a MAC clause to terminate an agreement on the basis of circumstances it knew about at the time of agreement, unless those circumstances have themselves materially changed.

Blair J held that, in the instant case, there had been a MAC in the borrower's financial condition amounting to a default and that the lender was entitled to refuse to make further advances. The borrower had also failed to provide accurate information on the project's progress.

For further information on this decision, see Legal update, MAC representation and rescheduling indebtedness event of default considered (High Court).

Cukurova Finance: subjective MAC clauses

In Cukurova Finance International Limited and another v Alfa Telecom Turkey Ltd [2013] UKPC 2, the Privy Council considered the application of a subjective MAC clause, where the existence of a MAC fell to be determined by reference to one party's opinion rather than an objective standard. Although a Privy Council decision, and therefore not strictly binding in this jurisdiction, it is likely to be persuasive should the same issue fall to be considered by an English court.

The parties accepted that the MAC event of default clause did not require the relevant event to have an objectively adverse effect. Rather, all that was required was for the lender (Alfa Telecom), to have actually formed an opinion, which was honest and rational, that there had been an adverse effect. Alfa Telecom was entitled to decide for itself whether the MAC clause was satisfied.

The Privy Council held that there had been a MAC event of default under the facility agreement.

It held that there was sufficient evidence which showed that Alfa Telecom had formed an opinion that an event falling within the terms of the relevant MAC clause had occurred. This opinion was held to be honest and rational. Importantly from an evidential perspective, Alfa Telecom's sole director had signed a letter to Cukurova Finance International Limited and Cukurova Holding AS (the borrowers), which alleged the events of default. This was evidence of Alfa Telecom's opinion.

For further information on this decision, see Legal update, Material adverse change event established and appropriation not invalid but relief from forfeiture available (Privy Council).

Practitioners should note that the bar of "honest and rational" is likely to be a low one. Although not relied on in Cukurova, the meaning of "rational" was considered by the Supreme Court in the context of harassment in Hayes v Willoughby [2013] UKSC 17. The Supreme Court in Hayes noted that rationality is not the same as reasonableness, which is an external, objective standard applied to the outcome of a person's thoughts or intentions. By contrast, rationality applies a minimum objective standard to the relevant person's mental processes. Rationality imports a requirement of good faith; that is, that there should be some logical connection between the evidence and the ostensible reasons for the decision and (which will usually amount to the same thing) an absence of arbitrariness, of capriciousness or of reasoning so outrageous in its defiance of logic as to be perverse.

For general information on the requirement for rationality in the exercise of discretion, see Practice note, Contracts: good faith: The duty of rationality (the Braganza duty).

Courts' consideration of MAC clauses in UK acquisition agreements

In Ipsos SA v Dentsu Aegis Network Ltd [2015] EWHC 1726, the High Court considered a MAC clause in a share purchase agreement, which entitled the buyer to terminate the agreement if something happened in the period between signing and completion that had a "Material Adverse Effect". Although this was only the hearing of a strike-out application, and is therefore of limited precedent value, it nonetheless indicates the likely approach of the courts to issues of contractual construction arising from MAC clauses.

It was common ground in this case that the definition of a Material Adverse Effect in the agreement had two constituent elements: (a) an act or omission or the occurrence of a fact, matter, event or circumstance; and (b) with a causal effect, namely the material adverse effect.

It was, in the judge's view, arguable that the fact that the actual financial performance of the target company was significantly worse than forecast satisfied both elements of the definition of a Material Adverse Effect. However, the buyer did not have an arguable case in respect of the mere downward revision of the target's financial forecasts.

In relation to the revised forecasts, the court considered that:

The revision of forecasts did not fall naturally within the requirement in the definition of a Material Adverse Effect that there be an act or omission, or the occurrence of a fact, matter, event or circumstance.
The causal effect of the revisions to the forecasts was tenuous.
The buyer's suggested construction of the Material Adverse Effect condition did not make sense commercially, particularly given that the parties had agreed that no warranty was given by the seller as to the accuracy of forecasts.
If the forecasts were held to fall within the Material Adverse Effect condition, this would lead to uncertainty which is highly undesirable in the mergers and acquisitions market (presumably in the sense of giving parties a back door with which to exit a deal).

For further information on this decision, see Legal update, Acquisitions: construction of material adverse change clause (High Court).

Travelport v Wex: MAC clause invoked due to COVID-19 pandemic

In Travelport Ltd v Wex Inc [2020] EWHC 2670 (Comm), the High Court considered, in a trial of preliminary issues, the construction of a material adverse effects (MAE) clause in a share purchase agreement, which the buyer sought to invoke as a result of the COVID-19 pandemic.

Completion of the agreement was conditional upon the satisfaction of certain conditions, including an MAE condition, which provided that between exchange and completion:

"…there shall not have been any Material Adverse Effect and no event, change, development, state of facts or effect shall have occurred that would reasonably be expected to have a Material Adverse Effect".

Following exchange, the buyer sought to invoke the MAE condition and withdraw from the transaction due to the negative impact of the COVID-19 pandemic on the target companies.

The definition of an MAE for the purposes of the condition was subject to several carve-outs, which identified certain matters or events that would not constitute or contribute to an MAE. These carve-outs included conditions resulting from pandemics. However, the carve-out in respect of pandemics was itself subject to an exception which disapplied the carve-out in relation to any adverse event that otherwise fell within the carve-out if the event had "…a disproportionate effect…" on the target companies as compared to other participants in the industries in which they operated.

The central issue concerned the construction of the exception to the pandemics carve-out, namely, for the purposes of determining whether the exception was engaged, what objectively did the parties mean when they referred to "the industries" in which the target companies and their subsidiaries operated? The sellers argued that the relevant industry for comparison was the narrowly drawn travel payments industry, which it defined as being the industry of providers of products and services to facilitate business to business payments to participants in the travel industry. However, the court rejected the sellers' construction, instead preferring the buyer's interpretation that the appropriate comparator was the more widely drawn B2B payments industry. The court considered that the word "industry” was a broader term than others that might have been used (such as market, sector or business), which in its natural and ordinary meaning captured a group of participants in a broad sphere of economic activity, and that the evidence failed to establish that there was a distinct travel payments industry (either within the meaning ascribed to the term by the sellers or in any broader sense).

For further information on this decision, see Legal update, COVID-19: construction of material adverse change clause in SPA (High Court).

MAC clauses before the US courts

The Delaware Chancery Court in the United States has issued several important decisions interpreting MAC provisions, and a number of examples are considered below. The general approach of the Delaware courts is to interpret MAC clauses narrowly, and in a seller-friendly manner. It is also clear that buyers must meet a very high standard to establish that a MAC has occurred. It is telling that until 2018 (and the decision in Akorn, Inc. v. Fresenius Kabi AG, (Del. Ch. Oct 1, 2018)), none of the cases that came before the court involved a finding that a MAC had occurred.

Re IBP, Inc. S'holders Litig., 789 A.2d 14 (Del. Ch. 2001). The buyer, Tyson, sought to terminate its agreement to acquire IBP because of material adverse change, based on IBP's poor earnings performance over two quarters and a small asset write-down. The court held that a broadly drafted MAC clause is best read as a backstop, protecting the buyer from the occurrence of unknown events that substantially threaten the overall long-term earnings potential of the target. The determination of materiality should look at the long-term effect on earning power over a commercially reasonable period measured in years rather than months. The decision also indicated that it is difficult to use the clause as protection from the consequences of a problem disclosed to the other party. The onus is on the buyer to consider what the ramifications of the disclosure might be because the buyer is treated as being on notice of the reasonably foreseeable consequences of that problem. For further information on this decision, see Article, Untying the knot: Material adverse change clauses: IBP v Tyson, Practical Law Magazine, 2002.
Hexion Specialty Chemicals v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008). Hexion, an affiliate of private equity firm Apollo Global Management LLC, argued that it was not obligated to close its acquisition of Huntsman because Huntsman had suffered a MAC. Hexion pointed to Huntsman's failure to achieve its financial projections, but the court found that Hexion had not met its burden of proof. Confirming the pro-seller bias of Delaware judges reviewing MAC provisions, the court noted that it was "not a coincidence" that the Delaware courts had not previously found a MAC to have occurred in the context of an acquisition agreement. The courts findings included that:
- the burden of proof rests on the party seeking to excuse its performance under the contract absent unambiguous language to the contrary (acknowledging that the parties could contract explicitly on the subject);
- as found in Re IPB, a MAC must be assessed over “a commercially reasonable period, which one would expect to be measured in years rather than months";
- it was not appropriate to address carve-outs in the MAC definition before first determining if the business had suffered a material adverse change in the first place (see Analysis of Genesco’s MAC Definition). In the court’s view, unless as a threshold matter it determines that a MAC has occurred under the definition read without regard to carve-outs, it need not consider the application of pro-seller carve-outs to the definition, of MAC or any pro-buyer carve-outs to such pro-seller carve-outs; and
- the merger agreement required a MAC to be determined based on an examination of Huntsman and its subsidiaries, taken as a whole, and the court refused to focus on two divisions of Huntsman that had been particularly troubled.
Osram Sylvania Inc. v. Townsend Ventures, LLC, et al., (Del. Ch. Nov. 19, 2013). In 2013, ruling on a motion to dismiss, the Delaware Chancery Court gave guidance for when employee resignations and a company’s failure to meet sales numbers may trigger a MAC. Specifically, the court found it reasonably conceivable that the sellers had breached the MAC qualifier in certain representations as a result of the company’s manipulation of sales figures and failure to meet the sellers’ sales projections. At the same time, the court held that the resignation of two key salespeople could not form the basis for a breach of the MAC qualifier in certain representations. The buyer argued that the resignations were material enough to the business’s long-term performance to constitute a MAC. The court disagreed, holding that though it is possible for certain resignations to constitute a MAC, it was not reasonably conceivable that these two resignations constituted a MAC because the significance of the two employees in this case was based on their projected sales performances, which was speculative and uncertain. Additionally, the court also found that the buyer’s failure to include the two salespeople in the list of “Key Personnel” undermined its argument that their resignations held material importance for the business.
Akorn, Inc. v. Fresenius Kabi AG, (Del. Ch. Oct. 1, 2018). In a landmark post-trial opinion, the Delaware Chancery Court held for the first time that a target company had suffered a MAC under the terms of a merger agreement, allowing the buyer to terminate the agreement. The court ruled that Fresenius was justified in terminating its merger agreement with Akorn due to both a failure of the MAC closing condition and the bring-down closing condition that required Akorn’s representations and warranties (in this case pertaining to regulatory matters) to be true and correct as of closing except where the failure would not reasonably be expected to have a MAC. The matters at issue included whether Fresenius had assumed the risks that led to the MAC due to what it had learned in due diligence, or generally because it was on notice due to its industry knowledge. While acknowledging that the court in Re IBP had found that a MAC provision "is best read as a backstop… [for] unknown events," the court in Akorn refused to limit the protection of a MAC, absent contractual language to contrary, to solely unknown events. The court noted that while the target company had the opportunity to negotiate the express language of the MAC to limit the definition of a MAC to solely "unforeseeable effects, changes, events, or occurrences," or could have added additional exceptions to the MAC definition to exclude "matters disclosed during due diligence, or even risks identified in public filings," it did not. When negotiating a MAC clause, US buyers may therefore wish to provide expressly that all events, circumstances, changes, or effects relating to the business, whether known or unknown at the time of execution of the acquisition agreement, and regardless of the course of dealing between the parties in connection with the transaction, will be considered in determining whether a MAC has occurred.

Material adverse change (MAC) clauses: acquisitions | Practical Law