Despite their popularity, it is widely accepted that a material adverse change (MAC), also known as a material adverse effect (MAE) condition, is notoriously difficult to trigger. A situation not contemplated might have occurred or a contemplated situation might have a lesser adverse impact than anticipated and therefore the clause is not triggered.  One party might want wider conditions while, unsurprisingly, the other party would want narrower ones. However, before we delve into the issues, we need to know what is a material adverse change clause.

What is a Material Adverse Change Clause?

A material adverse change (or MAC) clause is common in M&A and financing contracts. Its purpose is to give one party the right to modify or terminate the deal or contract if there is an adverse change in the business that is material to the deal or contract. Not every change is adverse to all parties and for sure not every adverse change will have a material impact on the deal from the point of view of every party.

Therefore it is up to the parties to negotiate and define as clearly as possible what such a material adverse event is and its consequences to the deal. If the MAC event occurs between the signing and closing of the deal, it may result in the termination and unwinding of the deal. If it occurs after the closing but there are still obligations for one party to fulfill (as an example during earn-out periods), it may result in some or all of the obligations being waived. It may also provide for compensation or damages being paid by one party to the other. In financing arrangements, the MAC clause may result in repayment of the loan.

MAC clauses often come into focus in the aftermath of significant events that affect the economy, either generally or in a specific industry. Events such as 9-11, global financial crises, and the recent Covid-19 pandemic saw a discernible increase in acquirers trying to invoke MAC clauses to terminate a deal.

What a MAC clause contains will vary from transaction to transaction and jurisdiction to jurisdiction. In some countries, there might be a ‘market practice’ on how such clauses are usually drafted. But parties must bear in mind that notwithstanding market practices, you can negotiate something else that suits the circumstances of a deal.

MAC Clauses in ‘Private Transactions’

In private deals (and even in some deals involving listed or regulated entities), a MAC clause may take the form of either a condition precedent or a condition subsequent to completion. It can also be a warranty that there is no MAC as of a specified date. As a warranty, some acquirers will negotiate that the warranty is repeated at completion to avail of its effect to abort a deal. Sellers of course will resist.

From an acquirer’s perspective, MAC clauses should attempt to set out every issue or event that is material to an acquirer and to set out the reasons why that is so, especially if it is not clear on the face of that issue why it is material to the acquirer. It should also set out an objective threshold, where possible, to determine materiality. In rare situations, materiality may be left to the acquirer to determine at its discretion. MAC clauses often have carve-outs, that is situations when the MAC clause would not apply. Sometimes there is a third layer, exceptions to the carve-out. Such 3-layer MAC clauses are a common structure used in ‘American’ style or drafted agreements. Parties should also consider if the MAC clause can only be invoked when a material adverse change has occurred or that it can be forward-looking and allow the MAC clause to be invoked in anticipation of such a material adverse change.

A good illustration of the ‘3 layers’ MAC clause is the English case of Travelport Limited v WEX Inc [2020] EWHC 2670 (Comm).  The case concerned the interpretation of a MAC clause in a share purchase agreement wherein WEX Inc (“WEX”) agreed to purchase 100% of two companies, eNett International (Jersey) Limited (“eNett”) and Optal Limited (“Optal”) from Travelport Limited (“Travelport”). WEX attempted to use the MAC clause to abort the deal because of the Covid-19 pandemic.

The MAC (or MAE in this case) clause stated:

“Since the date of this Agreement 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.”

“Material Adverse Effect” was defined in the agreement as:

“any event, change, development, state of facts or effect that, individually or in the aggregate,

(x) has had and continues to have a material adverse effect on the business, condition (financial or otherwise) or results of operations of [the eNett Group], taken as a whole, or of [the Optal Group], taken as a whole…or

(y) would prevent or materially delay the consummation of the transactions contemplated by this Agreement”.

The relevant carve-out is a proviso to the above clause (x) and states:

“…provided that, solely for purposes of clause (x), no such event, change, development, state of facts or effect resulting, arising from or in connection with any of the following matters shall be deemed, either alone or in combination, to constitute or contribute to, or be taken into account in determining whether there has been or will be, a Material Adverse Effect:

a) the general conditions and trends in the industries or businesses in which [eNett], [Optal] or any of their respective Subsidiaries operates, including competition in any of the geographic or product areas in which [eNett], [Optal] or any of their respective Subsidiaries operates …

b) general economic conditions, financial conditions or capital market conditions (including interest rates, exchange rates and credit markets);

c) conditions resulting from the commencement, occurrence, continuation or intensification of any act of civil unrest, war (whether or not declared), terrorism or sabotage (including cyberattack), armed hostilities, military attacks or declaration of national emergency;

d) changes (or proposed changes) in Tax, regulatory or political conditions (including as a result of the negotiations or outcome with respect to Brexit) or Law, IFRS EU or IFRS IASB (or, in each case, any authoritative interpretations thereof or the enforcement thereof);

e) conditions resulting from any natural or manmade disasters, hurricanes, floods, tornados, pandemics, tsunamis, earthquakes, acts of God or other weather-related or natural conditions…”

And the exception to the carve-out is:

“provided, further that any event, change, development or effect referred to in clause (a), (b), (c) or (e) may be taken into account in determining whether there has been a Material Adverse Effect to the extent, and solely to the extent, such event, change, development, state of facts or effect has a disproportionate effect on [the eNett Group], taken as a whole, or on [the Optal Group], taken as a whole, as compared to participants in the industries in which [eNett], [Optal] or their respective Subsidiaries operate.”

The effect of the MAC clause, in the words of the Judge, is that  “[f]or present purposes all of this complicated structure produces this result: that if conditions resulting from the Pandemic cause a disproportionate effect on either of the eNett or Optal Groups, each taken as a whole, as compared to other participants in the industries in which either of eNett or Optal (or their respective subsidiaries) operate, such conditions fall within the Carve-Out Exception.”

It important to bear in mind that the agreement was dated 24 Jan 2020, just days before WHO declared the Covid-19 outbreak as “a public health emergency of international concern” on 30 Jan 2020 and almost two months before Covid-19 was classified by WHO as a worldwide pandemic on 11 March 2020.

It was not necessary for the judge to decide if WEX had properly invoked the MAC clause as the judgment was about a trial of preliminary issues. I cannot find anything as to what happened at the full trial or even if the full trial took place. All I can find is that the parties had entered into a deed of settlement and the deal was completed on 15 Dec 2020.

MAC Clauses in Takeovers of Publicly Listed Companies

The use of MAC clauses in takeovers of listed entities in some jurisdictions is regulated by the relevant authorities.

As an example, the Australian Securities & Investments Commission in its Sep 2022 update stated that it expects MAC conditions to have objective and quantifiable standards by which the parties to a transaction can determine whether the material adverse change has occurred. The MAC condition cannot be subjective or semi-subjective.

Unquantified MAC clauses are common in commercial drafting. Commercial parties and their legal advisors have for decades viewed such clauses as applying an objective test, and the suggestion in Australia that they need to be quantitatively defined as well has surprised the market. It would be a shame if other regulators follow Australia and unquantified MAC conditions can no longer be used as a key risk management device.

In another example, the City Code of Takeovers and Mergers of UK provides that for a bidder to invoke a MAC clause so as to cause a bid to lapse, the condition must not be subject to the subjective judgment of the directors of the bidder, nor should satisfaction of the condition be in the bidder’s hands. Further, the circumstances that give rise to the right to invoke the condition must be of material significance to the bidder in the context of the offer.

What Should Go Into a MAC Clause in an M&A Deal?

First and foremost, the considerations of an acquirer and of the seller are very different in an M&A deal. So let us start with considerations of the acquirer.

For Acquirer

If the acquirer is obtaining financing for the deal, make sure that the conditions align with the financing documents. You definitely don’t want to be caught in a situation where your financier can back out but you can’t.

Other considerations for an acquirer include:

• Whether to have a general MAC clause (usually strongly resisted by the seller with good reasons) or whether to have the clause cover specified concerns that the acquirer may have. Even if the seller agrees to a general MAC clause, an acquirer will still need to carefully craft what constitutes a MAC since courts generally interpret MAC clauses narrowly. The general MAC clause should also be looked at in the context of the agreement as a whole since the courts will interpret the intentions of the parties by looking at the documents as a whole.
• If the seller successfully negotiates ‘general markets events’ as being an exception to what constitutes a MAC, the acquirer should consider incorporating wordings that would still trigger the MAC clause if: (i) the target company is affected comparatively worse when compared to other companies in its industry or (ii) the industry in which the target company operates is disproportionately affected when compared to other industries.
• Look for what other protections that are available to the acquirer. As examples, obtain undertakings from the seller to run the target company ‘in the usual course of business’ in the period leading up to completion or negotiate for the warranties to be repeated at the completion of the transaction.
• As stated earlier in the article, see if you can include forward-looking triggers of a MAC clause with words like “… events that are reasonably expected to have a material adverse effect on earnings …”.
• If you need to specify events, other than the usual ones concerning the financial performance of the target company, consider adding one regarding the departure of key personnel or events that would impair the acquirer’s ability to complete the deal (eg no financing).
• If your MAC clause has both general provisions and specific events, bear in mind that a court will likely interpret the specific events in the MAC clause as exclusive and exhaustive, thus giving little or no effect to the general provisions.

For Seller

The starting position is to resist any MAC clause although this will often be viewed by any acquirer as unreasonable and has the potential to scuttle a deal. As a seller, you must have clear and cogent reasons for this stance. However, from a negotiator’s standpoint, it could make subsequent negotiations for limited and clearly defined MAC clauses easier. You can also try negotiating for a sunset to the MAC clause if the closing of the deal is delayed by the acquirer. After all, if the deal had been completed on the scheduled date, any risk of a MAC would have passed to the acquirer.

Conversely, if the seller is responsible for the delay in completion, the seller should try to minimise the period at which it may be at risk.

If the seller accepts the inclusion of a MAC clause, try to negotiate for ‘general market events’ exceptions and for ‘matters disclosed to or within the knowledge of the acquirer’ exceptions. Existing events should also be an exception to a MAC clause.

Also, look for objective criteria to determine what is material. Usually, parties resort to measurable financial parameters. This may mean, for example, that the valuation, the turnover, EBITDA, etc. of the target company declines by a number of percentage points. Bear in mind that often such financial parameters may not be available on a monthly basis or that the changes may be temporary. Acquirers often want a subjective criterion, that is, they make the determination. A possible but more expensive compromise is to have a third party make that determination.

Interpretation of MAC Clauses by Courts

MAC clauses in share sale agreements will be interpreted in accordance with general principles of law. A court, when interpreting any clause of any contract will first look to the words in the contract to determine the parties’ intention. If this still gives rise to ambiguity, the court will then look at the surrounding circumstances to determine that intention. Once a court has interpreted the meaning of the provision, it will then make a factual determination on whether a material adverse change, within the meaning of the provision, has occurred.

The determination of materiality is an objective one and not what one or the other party believes to be material. Materiality must be assessed at the relevant time, usually when one party asserts that a material adverse change has occurred. It is for the party asserting material adverse change to prove it and courts have said that this is a very high threshold. Therefore the claimant is likely to face a difficult uphill task.

Some additional points to note from another English case, Grupo Hotelero Urvasco v Carey Value Added [2013] EWHC 1039 (Comm):

• A change is only material if it significantly affects the company’s ability to perform its obligations under the relevant agreement.
• A change is not material if it is merely temporary.
• The party invoking the MAC clause cannot do so on the basis of circumstances of which it was aware at the time of the agreement.
• Where the MAC clause relates to a company’s financial condition, this is to be determined primarily by reference to its financial information, which may include interim financial information and/or management accounts.
• Financial information does not, therefore, encompass other matters such as the company’s prospects or external economic or market changes.
• However, an inquiry is not necessarily limited to the company’s financial information if there is compelling evidence to show that a material adverse change has occurred.

There is also a Singapore High Court decision, Downeredi Works Pte Ltd v Holcim (Singapore) Pte Ltd [2009] 1 SLR(R) 1070, interpreting the term “material” to mean “significant” in the context of a MAC clause.

Similar Type Clauses

Similar to MAC clauses are hardship clauses and force majeure clauses.  Hardship clauses and force majeure clauses aim to regulate the contractual relationship in cases of abnormal and unforeseeable circumstances occurring after the entry into force of the agreement. Hardship clauses usually achieve this by providing for renegotiation of the contractual terms and conditions. Force majeure clauses often provide for pre-determined consequences, including termination, if such circumstances arise.

Although the clauses have some similarities, the main distinction between such clauses and MAC clauses lies in their scope. Hardship clauses are directed at the performance of the contract. As an example in supply contracts, changes in certain circumstances trigger a renegotiation of supply volumes, prices and/or schedules.  The MAC clause on the other hand concerns a one-off transaction like in an acquisition or in financing.  Further, the consequences are also different. The MAC clause usually results in the termination of the arrangement or some part of the arrangement although on a practical level, parties usually enter into negotiations to see if the deal can be saved before triggering the MAC clause.

Final Points

It should be clear from the above that drafting MAC clauses that are effective is no simple task. Sellers and acquirers are almost diametrically opposite when it comes to MAC clauses. The end result after much ‘to-and-fro’ negotiation may be confusing and complicated. It is a task that even seasoned lawyers find daunting. Thus getting good and proper representation is important. The skill set required for your professional advisors should include negotiation skills, good drafting skills along with a sound understanding of the commercial drivers for the deal and of course, of the law.

If you need to know more how OTP Law Corporation can help with your deal, contact us.