Q&A: MAC clauses in M&A
June 2020 | SPECIAL REPORT: MERGERS & ACQUISITIONS
Financier Worldwide Magazine
June 2020 Issue
FW discusses MAC clauses in M&A with Monica Macheng at Bevan Brittan LLP and Hannah Cordwell at Kemp Little LLP.
FW: Could you outline the key implications of COVID-19 for M&A transactions? To what extent are parties more likely to include and invoke material adverse change (MAC) clauses in their deals?
Macheng: We are seeing a significant drop in M&A activity during the pandemic. Coronavirus (COVID-19) has impacted target companies’ revenues and liquidity, regulatory compliance, and supply chain and staff, with the result that deals are either being permanently or temporarily shelved, parties are seeking extra protections in respect of ongoing deals or reviewing the material adverse change (MAC) provisions that might apply where deals have exchanged but not yet completed. This is likely to continue while COVID-19 continues to spread globally, countries remain under lockdown and the severity of the global economic impact of the virus is unknown. The extent to which MAC clauses are used is unlikely to change as a result of COVID-19, although we anticipate that buyers will from now on seek to include the consequences of a pandemic as a MAC event, albeit this will be resisted by sellers. Since the outbreak began, we have seen a considerable increase in the number of buyers, which, having already exchanged contracts, have sought to invoke MAC clauses, albeit we are yet to see how many will successfully pull out and how many are in fact simply using it as an opportunity to chip the price. Whether buyers are successful in invoking MAC clauses will depend on the specific drafting of the clauses. It is unlikely that sellers will concede that a MAC is specifically related to the impact of COVID-19 unless it is linked to a specific risk or triggered by an actual financial impact in the period between exchange and completion.
FW: How concerned should sellers be that buyers may use the COVID-19 situation to try to delay deal completion and force the price down?
Cordwell: In the context of public M&A transactions, it was reported last week that Brigadier Acquisition was seeking to walk away from its agreed purchase of Moss Bros by invoking the MAC clause. While the takeover panel are considering Brigadier’s application to lapse its offer, target boards will be concerned to see the outcome of this, since traditionally the takeover panel has been loath to allow offers to lapse because of economic dislocation. A court will likely construe the conditions of a MAC clause narrowly, making it difficult for a buyer to successfully invoke a MAC, especially when the buyer may be judged to have known of the relevant circumstances when the agreement was entered into. Given that the outbreak was labelled a pandemic on 11 March, we think there are likely to only be a small number of deals in which a buyer could terminate by invoking a MAC due to COVID-19. However, a buyer may see a MAC as a helpful tool to reopen discussions on price.
Macheng: This is a reasonable concern for sellers – where deals have already exchanged. While the court is likely to interpret MAC clauses narrowly, in reality the threat of a dispute may result in a negotiation. Buyers are undoubtedly reviewing the provisions to assess the implications of any MAC on the target. Whether buyers’ attempts at delay or price chip are successful will depend on the negotiating position of the parties. Where deals have not already exchanged, we have seen buyers pulling out of transactions or putting them on hold with a view to re-evaluating the value of the target business after the crisis. For those deals still progressing to exchange, MAC clauses will be heavily negotiated.
“A buyer seeking to rely on a generic MAC condition in an agreement entered into after the COVID-19 outbreak was labelled a pandemic on 11 March 2020, would have a difficult time arguing that an adverse effect was unforeseeable.”
FW: What advice would you offer to parties on negotiating and drafting MAC clauses in their transaction documents, particularly with a view to clarifying potential MAC triggers?
Macheng: Parties need to be aware that, generally, courts are reluctant to permit buyers to terminate a purchase agreement and will interpret MAC clauses strictly, based on the usual contractual matrix of information, including what was in the contemplation of the parties at the time. The burden of proof to show that a MAC has occurred falls on the party seeking to rely on the MAC clause to terminate the contract, and a MAC clause cannot be triggered where the party seeking to rely on it already knew the basis of the circumstances when entering into the contract. That in itself raises some interesting questions about knowledge of the pandemic in what has been a fast-moving situation. MAC clauses should be informed by the complexities of the relevant industry to ensure that MAC events can be linked to a specific risk or triggered by an actual financial impact in the period between exchange and completion. For example, a buyer should try to include specific events or triggers which are easier to prove, and which therefore give greater certainty of being successfully enforced. Remember that COVID-19 is now a foreseeable risk, so trying to enforce a general MAC clause in the future on the basis of COVID-19 is unlikely to be successful because it will be in the contemplation of the parties – a sector-specific clause could, however, still be included.
Cordwell: The more specific a MAC clause is, the better from an enforceability perspective. For a buyer, it may be appropriate to try to expand the list of circumstances that will constitute a MAC, perhaps specifying that a loss of a key contract or an interruption of essential supply chains would be specific triggers for the MAC condition, rather than seeking to rely on generic material adverse change-type wording. On the other hand, a seller may look to gain certainty by expressly calling out such specific events and general exclusions, such as epidemics, pandemics or COVID-19, as events that would not constitute a MAC.
FW: Within a MAC clause, what events and conditions would sellers typically look to exclude? How are factors such as external economic or market changes likely to be treated by both sides?
Cordwell: As a starting point, a seller would usually resist the inclusion of a MAC clause in the acquisition agreement altogether. However, where an acquisition is being funded via a bank loan, or similar, and there is a split exchange and completion, a MAC-type clause may be necessary to tie back to the terms of the acquisition finance. If a buyer does succeed in negotiating the inclusion of a MAC clause, a seller would typically look to exclude matters that would ordinarily be at the buyer’s risk, such as changes in general market conditions, and would always ensure that the MAC is only triggered by circumstances that arise between signing and completion. A seller might also look to exclude specific matters relating to the performance of the target’s business, such as seasonal fluctuations in revenue, anticipated based on historic data relating to the target. The net effect would be to limit the MAC clause to a very specific, and cataclysmic, set of circumstances.
Macheng: From a seller’s perspective, sellers should seek to exclude the following. First, generic economic and market conditions. Second, epidemics, pandemics and outbreak of diseases. Third, warranties that warrant the future trading profits of the business. Fourth, MACs that are subjective to the buyer’s opinion, as well as industry wide, force majeure or otherwise generally applicable risks that the buyer already faces in its own business. Fifth, risks inherent in announcing and effecting the transaction or otherwise arising out of the buyer’s actions. Sixth, risks that the buyer has agreed to assume by reason of accepting their disclosure in the disclosure letter. Seventh, any material adverse change that is cured by the seller before completion. Eighth, acts of God or other natural disasters. Ninth, the identity of the buyer where suppliers or customers do not wish to trade with a company or business owned by the buyer. Tenth, seasonal or cyclical changes in the target’s business. Finally, any increase in competition in any market in which the target company operates. Buyers will often seek to include broad provisions relating to economic or market changes, albeit at the risk of them being too vague to be successfully enforced, while sellers will seek to limit or exclude the impact of economic or market changes, particularly where the buyer is in the same market as the seller.
FW: What considerations do buyers need to make when seeking to successfully invoke or enforce a MAC clause in the current environment?
Macheng: Courts are reluctant to permit buyers to terminate an agreement and will strictly interpret MAC clauses, with the burden of proof falling on the party seeking to rely on the clause. A buyer is well advised to seek expert advice to assess its chances of success before it looks to invoke a MAC clause.
Cordwell: If a MAC clause contains an exclusion for changes in general market conditions, the impact of COVID-19 is likely to fall within such an exclusion, although the buyer of, for example, a hospitality business, may seek to argue that COVID-19 affects the business disproportionately and potentially is within scope of the MAC clause. Careful drafting is absolutely key. If a target is adversely affected by COVID-19 in a manner that is peculiar to its operations or business circumstances, for example the termination of the target’s main supply contract, the buyer may have a better chance of successfully arguing that the change constitutes a MAC. However, a buyer seeking to rely on a MAC should not have knowledge of the relevant circumstances when the agreement is entered into. Therefore, a buyer seeking to rely on a generic MAC condition in an agreement entered into after the COVID-19 outbreak was labelled a pandemic on 11 March 2020, would have a difficult time arguing that an adverse effect was unforeseeable.
“We only anticipate a modest rise in MAC-related disputes in the coming months, albeit these are likely to relate to those transactions where exchange of contracts occurred prior to COVID-19.”
FW: To what extent do you anticipate a rise in MAC-related disputes, either through court proceedings or arbitrations, in the coming months?
Macheng: From a corporate transactional perspective, we only anticipate a modest rise in MAC-related disputes in the coming months, albeit these are likely to relate to those transactions where exchange of contracts occurred prior to COVID-19. For transactions entered into contracts since COVID-19, circumstances will be in the contemplation of the parties at the time the contracts were finalised, so it will be more difficult for buyers to argue that a MAC should apply – unless specifically drafted to cover COVID-19 or similar – especially where the buyer could have held off exchanging contracts until the macroeconomic situation and the business circumstances became clearer. Where we anticipate a greater rise in MAC-related disputes between lenders and borrowers is where the buyer is borrowing funds to finance the acquisition and the lender exercises its right to cease to provide finance due to a material adverse change in the borrower’s financial position or due to the general economic situation.
FW: Generally speaking, how do courts in your jurisdiction assess MAC conditions in connection with M&A transactions? What kinds of benchmarks and standards might be used to determine whether a MAC has occurred?
Macheng: Generally, courts strictly interpret MAC clauses. As a matter of public policy, the view is that courts should only intervene in negotiated contracts in limited circumstances. The starting point for the court will be the clause itself and the definitions in the contract – which is why legal advice is critical as to whether the clause is enforceable. The burden of proof to show that a MAC has occurred falls on the party seeking to rely on the MAC clause to terminate the contract and a MAC clause cannot be triggered where the party seeking to rely on it already knew the basis of the circumstances when entering into the contract. Accordingly, what was in the contemplation of the parties at the time will be critical. The court will also expect the change to be substantial and significant in duration.
FW: What essential advice would you offer to parties on mitigating risks arising from MAC clauses in their transaction agreements? What are your predictions for the use of MAC clauses in a post-COVID-19 environment?
Cordwell: A party seeking to rely on a MAC clause should try to expand the list of circumstances that will constitute a MAC, perhaps including loss of key contracts or interruption of essential supply chains as specific triggers for the MAC condition. On the other hand, the other party to the agreement should try to gain more certainty by expressly calling out such specific events and general exclusions, such as epidemics, pandemics or COVID-19, as events that would not constitute a MAC. In a post-COVID-19 world, we expect both parties to spend more time thinking about and negotiating MAC clauses and, in particular, focusing on the exceptions to when the MAC clause can be invoked. Specific carve outs of COVID-19 from MAC clauses have already started to enter the M&A market, for example Morgan Stanley’s acquisition of E-Trade, and we would expect to see such carve outs become a common feature.
Macheng: We anticipate that MAC clauses will continue to be used in M&A deals where there is a gap between exchange and completion and in finance documents. Carve outs will be critical and both parties will need to consider the clause in the context of the due diligence for the transaction and the current economic climate. Buyers should seek to include exceptions but be aware of the limitations in terms of enforceability. Sellers should seek to restrict exceptions to limit the potential arguments the buyer may subsequently raise in an attempt to reduce the price.
Monica Macheng is a corporate lawyer with particular specialism in acquisitions and disposals and corporate restructuring of businesses. Her expertise includes working with small and medium-sized enterprises (SMEs), owner managed business and entrepreneurs across a wide range of sectors. She has a particular focus on health and social care, including, care homes, domiciliary care, dentists, pharmacies and GP surgeries, as well as medical suppliers, not-for-profit organisations and healthcare professionals. She can be contacted on +44 (0)370 194 5024 or by email: monica.macheng@bevanbrittan.com.
Hannah Cordwell is an associate in Kemp Little’s corporate team. She works with clients to help them with private M&A, private equity and venture capital fundraisings or investments, management incentive schemes, corporate reorganisations and general company law matters. She can be contacted on +44 (0)20 7710 8038 or by email: hannah.cordwell@kemplittle.com.
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