July 2020 Issue
Since the outbreak of COVID-19, there has been a dearth of announced mergers and acquisitions (M&A). Some transactions have been postponed and others cancelled outright.
For those deals which are underway but not yet complete, the pandemic is creating additional challenges. Buyers and sellers are understandably looking to transfer risk and negotiate deal-protection mechanisms. One of the most heavily negotiated aspects is the material adverse change (MAC) clause.
Disputes involving MAC clauses were already becoming more common in 2019, so it is not surprising that they have gained more attention due to the COVID-19 crisis. The economic outlook has darkened in a very short space of time, throwing a shroud of uncertainty over deals everywhere. “In today’s market, financing may be tenuous, and previously committed lending sources may not wish to fund,” says Stephen B. Amdur, a partner at Pillsbury Winthrop Shaw Pittman LLP. “Claiming a MAC at the target level is one method a buyer can use to try to re-cut the transaction, delay the consummation or potentially walk away entirely.”
Under normal circumstances, parties would typically only invoke a MAC clause as a last resort. But nothing about the effects of the COVID-19 pandemic is normal. As the crisis continues to unfold, more buyers are likely to consider whether a MAC clause may be used to terminate an acquisition if they believe there has been an adverse change in the financial condition, results or prospects of a target company. In some cases, this may be driven by a buyer’s inability to access acquisition financing on favourable terms.
It is too soon to tell whether the COVID-19 crisis will lead to a spike in successfully invoked MAC clauses, but in many jurisdictions the bar is set high. “In the US, Delaware courts have continually shown a disinclination to find a MAC has occurred, especially with respect to events that the parties may have known about at the time of a transaction,” points out Mr Amdur.
“Under normal circumstances, parties would typically only invoke a MAC clause as a last resort. But nothing about the effects of the COVID-19 pandemic is normal.”
According to Kathy Martin, a partner at McMillan, success in invoking a MAC clause will depend on the specific wording of the clause and the extent to which COVID-19 impacts the target or borrower. “In M&A, if the MAC clause is too general it is not likely to extend to a pandemic,” she suggests. “Other considerations include whether the buyer can establish that the target’s financial deterioration is likely to be sustained over a prolonged period of time and is solely attributable to the pandemic, and whether the buyer had knowledge of COVID-19 at the time the agreement was signed.”
In the short term, buyers and sellers are increasingly focused on the MAC clause, negotiating definitions and exclusions that may constitute a trigger. “Morgan Stanley’s acquisition of E-Trade Financial and the business combination of Aon PLC and Willis Towers Watson, both executed following the initial outbreak, both specifically contemplate how effects of the COVID-19 pandemic will be treated,” explains Mr Amdur. “Specifically including or excluding the ramifications of the pandemic among the exclusions from the MAC definition gives the parties greater certainty and gives a court clarity on the approach contemplated by the parties to the transaction if a dispute later arises.”
With COVID-19 and the potential for other ‘black swan’ events front-of-mind for the foreseeable future, buyers may be keen to include bespoke MAC clauses in their future deals. But sellers are likely to resist. “Buyers and lenders will want to carefully draft MAC clauses in new agreements, however entering into a new agreement with knowledge of the COVID-19 crisis may prevent a buyer or lender from claiming that COVID-19 caused a MAC,” says Maria Sagan, a partner at McMillan. “Sellers and borrowers, on the other hand, will want COVID-19 specifically excluded from MAC clauses. In M&A transactions, we are seeing a movement towards contemporaneous ‘sign and close’ structures in order to avoid having to negotiate a MAC closing condition.”
As Ms Martin points out, the fact that buyers and sellers prioritise different aspects when considering MAC clauses will spark points of contention between them. “From the buyer’s perspective, MAC clauses should be drafted to include specific events or triggers that may occur due to the economic impact of pandemics, such as disruption to the supply chain causing a measurable drop in revenue or increase in liabilities,” she says. “From the seller’s perspective, this specificity is not desirable. Sellers should seek to expressly exclude from MAC clauses the effects of pandemics and general market conditions and resist any language regarding future-looking impacts.”
In order to get deals through to completion, cooperation will be key. “Given the ongoing pandemic, buyers and sellers need to come to an agreement on how to share an entirely new category of risk if they wish to move forward with new transactions,” says Mr Amdur. “Relying on a MAC clause as a saviour later will be a gamble at best.”
© Financier Worldwide
BY
Richard Summerfield