Material Adverse Change clauses in M&A Transactions in light of the global Covid-19 pandemic

Material Adverse Change clauses, also known as Material Adverse Effect clauses, (“MACs”) are sometimes used in M&A transactions for the acquisition of a target or business. MAC clauses give the buyer the right to withdraw from the transaction between signing and closing, upon the occurrence of certain events which are deemed to be detrimental to the target company. They are usually included as a condition precedent to completion or as a warranty that the target has not suffered a MAC between signing and completion. Situations may now arise where parties have entered into an agreement for the acquisition of a target, and between signing and completion there has been a material change in the circumstances as a result of the global effects of Covid-19.  

“Τhe global situation relating to Covid-19 is developing incredibly fast and business operations can be materially affected by travel restrictions, quarantines and sudden lockdowns”

Typically, a buyer will seek a widely drafted MAC clause covering a MAC to the target company in question in terms of current business, financial position and future prospects. Conversely, the seller will seek a much narrower clause, which avoids references to future prospects and excludes general MAC provisions which affect the industry as a whole. This can lead to substantial negotiations between the lawyers of each party.

While English case law on how MACs are treated by the Courts is limited, it seems to abide by certain principles first outlined in the Delaware case of Grupo Hotelero Urvasco SA v Carey Value Added SL[i]. In particular, this case highlighted that a MAC must be material and not merely temporary, the burden of proof lies on the party seeking termination of the contract and a MAC cannot be triggered if such party was aware of it at the outset. The Courts have taken a very language specific and factual approach, based on contract law principles of interpretation, to determining whether a MAC has occurred and the buyer faces a heavy evidential burden to prove his claim[ii]. This makes litigation rather unpredictable, as it will each time depend on the specific wording of the clause used in the specific contract.

One would expect that it would be difficult for a buyer to prove a MAC occurred in light of an ongoing pandemic which existed pre-signing. It can be inferred that if a particular event is reasonably foreseeable, the buyer has accepted the risk. In light of the Covid-19 outbreak, buyers entering into share purchase agreements governed by English law can, prima facie, be considered to be on notice of the global pandemic. However, this is not absolute, since the global situation relating to Covid-19 is developing incredibly fast and business operations can be materially affected by travel restrictions, quarantines and sudden lockdowns, leading to staff shortages, delays and problems in supply chains. A buyer cannot trigger a MAC clause if he was aware of the circumstances upon entering into the agreement, unless he can prove that the circumstances are much worse and materially different. A continuing event cannot be considered a MAC as there is no change.

It is therefore of utmost importance that a potential buyer pays close attention to the drafting of a specifically worded MAC clause outlining specific events and specific consequences or thresholds in order to provide certainty, rather than a generic MAC clause. Yet the buyer would still have a high bar to reach as the impact arising from a MAC cannot be temporary in nature[iii] and must have a dispropiortionate effect on the target company compared to other participants in the industry. In the context of M&A transactions, there must be a significant change in the types of financial and economic challenges arising between signing and completion. This can be determined on the basis of accounts and the change must be significant[iv]. On the flip side, a seller would seek to expressly exclude Covid-19 and its effects from any MAC clause.

[i] Grupo Hotelero Urvasco SA v Carey Value Added SL

[ii] IBP Shareholders Litigation v Tyson Foods Inc

[iii] Decura IM Investments LLP & others v UBS AG

[iv] UK Thomas Witter v TBP Industries

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