Why the coronavirus makes material adverse change (MAC) clauses more important than ever

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Material adverse change, or MAC, clauses are increasingly prevalent in M&A deals, finds a recent study conducted by Nixon Peabody. Out of the 200 deals the law firm reviewed, 196, or 98 percent, contained a MAC clause in the business, operations and financial conditions of the target, up from 87 percent in 2018. More buyers are seeking protection if a target suffers from an economic or industry downturn. Dick Langan, a partner in the law firm's corporate practice, led the study. Mergers & Acquisitions asked Langan how buyers and sellers benefit from MAC clauses.

How does the coronavirus threat affect the need for MAC clauses?
The coronavirus threat is the type of risk that material adverse change, or MAC, clauses are designed to address. The MAC clauses are used to qualify representations, warranties and covenants in an acquisition agreement, establish a threshold for determining the scope of disclosure or compliance relating to risks associated with the target’s business, and to delineate the circumstances in which a bidder is permitted to a transaction without liability. Since coronavirus could impact a target company’s supply chain, personnel, revenues and liquidity, it is the type of risk that could result in significant negotiation between the parties.

What should dealmakers do about it?
It’s possible that a bidder in an M&A transaction would take the position that the effects of the coronavirus on a target company constituted a material adverse change. As a result, target companies may try to insert a specific exception in the MAC definition to an acquisition agreement that provides that the effects of coronavirus do not constitute a MAC. The reasoning for the exception would be that the parties know about the coronavirus threat at the time of signing of the agreement and should be able to factor its effects into their deal pricing and further that, while the Coronavirus may adversely affect short-term results of a company, the effects are not likely to be unforeseen, significant and other than temporary. Bidders may argue that the potential impact of coronavirus is far from clear (and, therefore, unforeseen) and short-term impacts, whether on the supply chain, revenue or liquidity or otherwise, could have significant, long-term consequences. In addition, a bidder may argue that a coronavirus exception is not necessary because the target may be able to rely on a traditional force majeure exception and that.

How are material adverse change (MAC) used in deals?
MAC clauses are used to allocate risks between bidders and targets in acquisition agreements. They serve as a risk allocation device with regard to deal certainty insofar as these agreements may require the absence of a material adverse change at the time of closing as a condition precedent. This condition precedent provides bidders with a mechanism to seek to walk from a deal or renegotiate price or deal terms if a MAC occurs between the signing and closing of an acquisition agreement. MAC clauses also serve as a risk allocation device when used to qualify representations and warranties and covenants in an acquisition agreement because they essentially allow a threshold for determining the scope of disclosure or compliance relating to risks associated with changes in the target’s business.

What are the benefits of MAC clauses?
The MAC clause can provide parties with a level of comfort as to the certainty of closing and certainty as to the pricing of the deal. When used as a closing condition, the clause provides the buyer with a liability-free walkaway under specified circumstances, which, if defined in a way that balances concerns of the buyer and the target, simultaneously can allay the target’s concern as to whether post-signing changes in the business may enable the bidder to terminate a transaction without liability and, when used in representations, warranties and covenant, can allay the target’s concern as to whether immaterial noncompliance may result in liability.

How enforceable are MACs?
Most litigation over MAC clauses result in negotiated settlements between bidders and targets, resulting in either price or walkaways being negotiated by the parties. In the limited number of reported decisions concerning MAC clauses, the courts generally have taken the view that for an event to constitute a MAC it must be significant, it must not have been reasonably foreseeable at the time of signing of the acquisition agreement, and it must not be temporary—in fact, it must have a long or lasting impact. Akorn v. Fresenius is the Delaware Chancery Court decision that a MAC had occurred that triggered a termination right in the acquisition agreement. The holding demonstrates that the courts are willing to invoke MAC clauses under the right circumstances. The circumstance in Akorn were significant enough to allow the court to conclude that the “heavy burden” required of showing that an event was of significance to the target’s long-term earning power and durationally significant. In that case, the target suffered a sudden and sustained drop in business performance evidenced by an 86 percent decline in EBITDA and 51 percent decline in adjusted EBITDA during a long pre-closing period, and made representations about regulatory compliance that proved to be materially incorrect due to a government investigation that uncovered serious and pervasive data integrity. The regulatory compliance issues that came to light as a result of whistleblower complaints were made after the signing of the acquisition agreement.

How have MAC clauses increased?
We’ve seen the increased use of MAC clauses that reflect political risks or changes in reporting or regulatory matters that are current but increasingly understood and accepted as risks affecting businesses generally. Examples of those exceptions that have been introduced into MAC clauses include exceptions for Brexit-related risks and regulatory law changes.

How do MACs favor buyers?
Due to the proliferation of exceptions to what constitutes a material adverse change on the target’s business, there have not been significant pro-bidder changes in MAC clauses. One notable exception is the increased inclusion in the definition of events that “reasonably could be expected to result” in a MAC has tended to develop a market norm of including a forward-looking element in the clause and thereby has reduced negotiation over whether events affecting a target’s prospect should be included in the definition. In addition, the trend toward increased uniformity in MAC clauses tends to reduce the level of negotiation of MAC clauses. In a deal environment where getting to the signing and announcement of the acquisition is critical, the increased uniformity assists bidders in avoiding getting bogged down in the negotiation of the MAC clause.

What is your outlook on MAC clauses in 2020?
MAC clauses will continue to be important risk allocation feature of acquisition agreements. Exceptions used in MAC clauses, which describe events that should not constitute a MAC, unless they disproportionately affect the target. They will continue to evolve in order to address changes in the financial markets, geopolitical issues and the like that deal practitioners believe are appropriate risks to be borne by the bidder effective upon the signing of the acquisition agreement.

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