COVID-19: Is it a material adverse change in M&A transactions?

With buyers looking closely at deal protection mechanisms, one question is whether a MAC clause can be used to help protect them against the impact of COVID-19

27 March 2020

With the economic impact of COVID-19 continuing to evolve and the uncertainty this is causing many companies, buyers are looking hard at deal-protection mechanisms both in transactions which have completed and those which are under negotiation. One of the most commonly used and heavily negotiated tools, when there is a gap between signing and closing, is a material adverse change ('MAC') clause. Sellers will be keen if at all possible to avoid any conditionality which is likely to result in a delay to the receipt of sale proceeds.

In this short article, we consider when a MAC clause may be used and the impact of COVID-19 on a MAC clause.     

What is a MAC clause?

Where there is a gap between exchange/signing of an acquisition agreement and completion of the acquisition of shares or assets, the inclusion of a MAC clause will always be a topic of discussion. A MAC clause essentially allows one party (usually the buyer) to pull out of the acquisition prior to completion in the event that a material adverse change has occurred in the period between exchange and completion which adversely affects the target company.

By no means will all acquisitions feature a MAC clause and indeed MAC clauses have in recent times been less common. The inclusion of a MAC clause typically shifts risk on to the seller and can leave it exposed to events outside of its control so, as such, a seller will generally resist its inclusion. If the time period between exchange and completion is likely to be short or the seller is in a strong negotiating position, a buyer may be willing to accept that it does not have a walk away right.  Alternatively, depending on the nature of the condition, it may be possible to delay signing until, for example, TUPE consultation has occurred.

Will the COVID-19 outbreak amount to a MAC?

UK market practice has typically been to include a generic MAC clause without specifying in detail the events constituting the MAC. This has left the courts to assess whether the event is a MAC in the context of the particular set of circumstances. 

In English law there have only been a handful of reported cases in which the courts have considered MAC clauses in the context of private M&A transactions, but these set a high benchmark. The broad principles applied by the courts are:

  • MAC clauses are interpreted in accordance with the usual principles of contractual interpretation, including considering the language agreed by the parties in the contract as a whole and the facts known to the parties when they entered into the agreement;
  • they will look at the specific wording of the clause and the facts surrounding it;
  • the party seeking to invoke the clause and terminate the agreement bears the burden of proving a MAC has occurred and it cannot trigger a MAC clause on the basis of circumstances it was aware of when it entered the agreement; and
  • a MAC will not be established by reference to external economic or market conditions unless the MAC clause specifically includes those circumstances  it is common for MAC clauses to specifically exclude events which affect the whole market.

In Ipsos SA v Dentsu Aegis Network Ltd, Ipos brought a claim on the basis that Aegis had failed to notify it of events which amounted to a MAC, that being the revision of financial forecasts of the company. Ipos argued that it had lost out on the opportunity to invoke the MAC condition and terminate the agreement. Aegis denied that the matters Ipos relied on amounted to a material adverse effect. The definition of 'material adverse effect' in the Ipos agreement consisted of two parts: '(a) an act or omission, or the occurrence of a fact, matter, event or circumstance; (b) affecting the target group giving rise to, or likely to give rise to, a material adverse effect on the business, operations, assets, liabilities, financial condition or results of operations of the target group taken as a whole'. On the facts it was held that the substantial downward revision of the financial forecasts was insufficient to trigger a MAC clause. This demonstrates the principle that the impact needs to be significant.

On public UK M&A transactions to which the City Code on Takeovers and Mergers applies, bidders will be required to demonstrate to the UK Takeover Panel that exceptional circumstances have arisen affecting the offeree company which could not have reasonably been foreseen at the time of the announcement of the offer (see (Panel Statement 2001/15)). This bar is a high one, established when the Panel rejected WPP’s attempt to withdraw from its offer for Tempus, which featured a MAC clause, following the 9/11 terrorist attacks, when, in WPP’s view, this had resulted in a significant deterioration in Tempus’ long-term prospects.

Invoking a MAC clause to terminate an acquisition agreement is usually only a last resort. However, as the COVID-19 outbreak continues to develop globally, we may see more buyers trying to use this route to terminate an acquisition where there has been an adverse change in the business, financial condition, results or prospects of a company and where the buyer may have issues with the acquisition funding being given. Where a generic MAC clause is included there is no certainty as to what will be required to trigger termination, but what we do know from the limited case law is that the Courts will set a high threshold so the MAC must be significant and have a long term or significant short term impact on the target company. 

Defining a MAC condition

Whether or not a party can invoke a MAC clause will ultimately come down to how it is defined in the agreement and its application to the underlying facts. A party will have a lot more certainty on its ability to rely on a MAC clause where it has been drafted with reference to specific events or triggers affecting the target company rather than changes which affect the market generally. For example a MAC definition which refers to a specific drop in revenue of the target or other specific financial metrics over a defined period will be much easier to rely on than a generic broad MAC.   

Dealing with current transactions

For acquisition agreements signed since the emergence of COVID-19 it is likely to be difficult to rely on a generic MAC clause in relation to changes in the economy or market caused by COVID-19. If an event was reasonably foreseeable before signing of the agreement the party seeking to invoke the MAC clause is likely to be treated as being aware of the current global health situation and the likelihood of increasing economic volatility caused by COVID-19 before they entered into the transaction, and therefore accepting the risk. However, if the MAC clause contains specific trigger events affecting the target company and those have occurred, there may be more scope to successfully invoke the MAC clause.

When entering into new agreements parties are likely to want to share the risk of business downturn, whether by using a MAC or structuring the deal in a different way, for example through an earn out. It would certainly be sensible to seek to include specific clauses addressing any potential issues relating to the COVID-19 outbreak. Where a MAC clause is agreed, the parties will need to make sure that the events and conditions which will amount to a MAC are objective and carefully defined. A 'corona' clause which specifically addresses the current situation may well be required although agreeing the parameters of that clause will be complex.

How can we help?

If you would like to discuss this briefing please speak to your usual contact at Burges Salmon or Richard Spink.

Key contact

Richard Spink

Richard Spink Partner

  • Head of Corporate
  • Mergers and Acquisitions
  • Private Equity

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