MACs Show More Teeth

As a result, or perhaps contributing to the spread of broken deals, material adverse change clauses have become more buyer friendly, as acquirers seek protections amid an uncertain environment.

As of December 1, the amount of broken deals that fell apart in the fourth quarter, valued at $322 billion, nearly matched the volume of announced deals, at $362 billion, according to Thomson Reuters. As of press time, cracks were also showing in the huge Roche Holding/Genentech merger and the buyout of BCE, making it very likely that the volume of abandoned deals would top the amount of actual M&A for the quarter. As a result, or perhaps contributing to the spread of broken deals, material adverse change (MAC) clauses have become more buyer friendly, as acquirers seek protections amid an uncertain environment.

Indeed, the onset of the recession and the ensuing volatility - be it from oil or commodity prices, exchange rates or even just consumer activity - has in many cases pitted buyers and sellers against one another creating a tug of war over deal terms that may seem outdated months or even weeks after signing. A recent survey conducted by law firm Nixon Peabody LLP, which looked at deals as low as $100 million over a 12 month span, revealed that fewer MAC exceptions are being given, reflecting the volatility that has many buyers on edge. Moreover, while MACs often lack teeth in the smaller deal realm, M&A pros note that increasingly small- and mid-market buyers are looking more closely at MAC provisions, especially in the more mercurial sectors, such as energy or consumer goods.

"It's seeping into the middle market," says Louis Rappaport, a partner at Blank Rome, adding "buyers are becoming more skittish."

To be sure, MAC provisions were applied with greater intensity to the largest deals Nixon Peabody surveyed. More than half of the largest M&A transactions examined included a MAC that covered, in some form, failure by targets to meet certain revenue or earnings hurdles. Considering the state of the economy, it's likely, deal pros say, that buyers will be even more insistent when it comes to including these particular provisions in the future.

In the small- to mid-market, however, this particular provision found its way into just over a third of the transactions surveyed. Deal pros say this is already changing, as buyers are seeking to establish bulletproof legal defenses should a deal's prospects evaporate pre-close.

There have been a few cases in recent memory that have forced buyers to think about MAC clauses beyond the boilerplate language that is typical in better times.

In February of last year, for example, a group of lenders led by Citigroup tried to back out of an agreement to provide exit financing to bankrupt chemicals maker Solutia. When the banks tried to renege, citing the market MAC provision, the jilted company filed a lawsuit. In its complaint, Solutia stated: "Their reliance on this clause, which they downplayed from the outset, is utterly without basis in the midst of a tumultuous market that was not only foreseeable, but had long existed when they signed on to the firm commitment."

While a settlement was quickly arranged, the case underscored why acquirers need to be specific when it comes to MAC clauses.

In a separate case that may have had a greater impact on influencing buyers, the Delaware Chancery Court ruled against Apollo Management and Hexion Specialty Chemicals, forcing the tandem to complete the $6.5 billion acquisition of Huntsman Corp. The burden of proof, vice chancellor Stephen Lamb ruled, resides with the buyers, who should be able to point to explicit language in a contract.

As a result, Rappaport says, "There's a heightened bar for buyers to overcome. Buyers will seek to tighten up a deal."

The current environment has made it more difficult for sellers to negotiate for exceptions within MAC clauses. The Nixon Peabody study revealed that fewer deals included MAC exceptions for changes in "general conditions of the specific industry," dropping to 70% from 75 percent. Also, of the deals surveyed, only 16% included a MAC exception for changes in interest rates, down from last year, and only 27% of the agreements contained MAC exceptions for regulatory changes, reflecting a 5% drop from last year.

While sellers have conceded to acquirer demands for more stringent MAC provisions, some deal pros cite that too many demands on the part of buyers can turn off sellers. And in the small and middle markets, deal teams are typically working under an abbreviated timeframe, which Paul Schneir, a managing director at KeyBank Capital Markets, says typically means that buyers won't seek to incorporate any overly byzantine provisions.

Still, Schneir said MACs will be used "as a threat" by the buyer who wants to ensure that the company being bought will still be performing at or above expectations for the four to six weeks that typically lapse between the signing of the agreement to the transaction's close.

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