Material Adverse Change Clauses in the Wake of COVID

The COVID-19 global pandemic will significantly shape how parties to mergers & acquisitions (M&A) deals view, and likely negotiate, Material Adverse Change (MAC) clauses in a deal’s transaction documents. MAC clauses are contractual provisions which aim to give a buyer the right to walk away from a deal prior to closing, upon the occurrence of events that are detrimental to the target’s business during the period between signing and closing. Typically, a MAC will define, either broadly or specifically, any development, event, condition, state of circumstances, etc., that have had, or would reasonably be expected to have, a material adverse effect on the business, assets, financial condition, or results of operations of a target business. Generally, a MAC excludes various categories of broader market or industry risk

In an M&A deal MACs may take several forms:

• The parties may include a standalone condition to closing that no MAC has occurred;

• The seller may give a representation or warranty that no MAC has occurred prior to closing; or

• The occurrence of a MAC may give a buyer the right to unilaterally terminate an agreement with no penalty before closing.

When MAC clauses are included in deal documents, the definition and events constituting a MAC can be strenuously negotiated. Broadly-drafted definitions (which buyers typically favor) will permit a buyer to walk away from a deal if there is any adverse change in the target’s business or general market conditions, and may even reference specific events such as the loss of a certain number of key customer relationships. Conversely, a narrower MAC definition (which sellers will want to achieve in practice) will limit the universe of events that constitute an “adverse change”, including by carving out any “adverse change” with a wide-ranging economic impact that does not disproportionately impact the target’s business.

MAC clauses are fairly common in M&A deals as either standalone closing conditions or representations that no MAC has occurred. The standard for determining whether a MAC has occurred will likely depend on the jurisdiction that is governing the deal. For instance,  in transactions governed by Delaware law, the legal standard for determining if a MAC has occurred turns on “whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.”  Hexion Specialty Chemicals v. Huntsman, 965 A.2d 715, 738 (Del. Ch. 2008).

In the future, the COVID-19 experience will most likely cause parties to an M&A deal to place a greater importance on MAC clauses – sellers are likely to want to negotiate more specific carve-outs from them to prevent matters originating from events such as COVID-19 (or similar future pandemics) from constituting a MAC. Conversely, a buyer might insist on a definitive termination right from a deal if the target business suffers a materially adverse (even if only short-term) impact due to COVID-19 and similar events. These more specific walk-away rights may take the form of closing conditions tied directly to potential vulnerabilities or issues of concern with the target or its operations.

As businesses navigate their way through the impact of the COVID-19 pandemic, it is probable that sellers in M&A deals will negotiate for more precise references to pandemics and epidemics in the exceptions of a MAC clause, whereas buyers will be negotiating for broad definitions of the same.

Alex Monahan is an associate at Lippitt O’Keefe, PLLC. He focuses his practice on business and corporate law, real estate law and commercial litigation.