COVID-19: The key legal principles surrounding the Material Adverse Change (MAC) Clause
What is a Material Adverse Change clause?
A material adverse change clause (MAC) is something frequently found in acquisition agreements, finance documents and commercial contracts. It potentially allows a party to terminate or adjust its obligations in the event of a change in circumstances which significantly effects the value of the target, the viability of the borrower or the position of the contract counterparty.
In M&A, a MAC typically covers the period between the signing of the transaction agreement and the closing of the transaction.
Interpreting the MAC Clause
It is often the case that MAC clauses are drafted in general terms and can be ambiguous, falling short of specifying what exactly constitutes a 'material adverse change'.
In instances where the definition is unclear, it is left to the courts to use a fact based inquiry to determine what constitutes a material adverse change, and whether in the particular circumstances a party can claim they have a right to invoke the clause.
Courts have traditionally been reluctant to find that a party can walk away from a transaction due to a material adverse change, unless it can show that the target suffered a significant and long-term impact.
There is some guidance in judgments on MAC clauses from the United States. Whilst there is relatively little in the way of English authority on the subject, a 2013 judgement provides useful insight into the English High Court’s interpretation.
Grupo Hotelero Urvasco SA (the Group) v Carey Value Added SL [2013] EWHC
The English High Court handed down a rare judgment on the interpretation of MAC provisions.
At the heart of the argument was an assertion by one of the Group's lenders that a MAC had occurred as a result of a deterioration in the financial condition of the Group. This was brought about in part by the 2008 global financial crisis (in particular, by foreign exchange fluctuations and reducing property values in Spain).
The court found that a MAC had not occurred, finding that on the specific drafting of the particular MAC, it was for the lender to prove an adverse change in financial position significant enough to affect the borrower's ability to repay the loan. In this case, it found that the Lender had failed to do so.
The court provided the following guidance:
- MAC provisions will be construed in accordance with usual principles of contractual interpretation. Therefore the precise words within the contract are relied upon
- To be material, the adverse change must substantially affect the ability to perform the transaction in question
- The change in question cannot be temporary or transitory
- A party cannot rely on a MAC on the basis of circumstances of which it was aware at the time of the agreement, although it may do so where conditions worsen in a way that makes them materially different in nature
Can a MAC clause be invoked due to the effects of COVID-19?
As matters currently stand, invoking a MAC clause due to COVID-19 issues may be difficult due to the fact that the long-term effects on financial and operational aspects are yet unknown.
Globally significant events are unusual and there are no litigated examples in the UK of MAC provisions being invoked as a result of epidemic or pandemic events, such as the 2003 SARS epidemic or the 2009 swine flu pandemic.
However, we are in largely unprecedented territory. Since the impact of COVID19 upon businesses is more extreme than has previously been seen, the courts may take a more sympathetic approach.
When a generic MAC clause is relied upon, the counterparty relying on it must not be aware of the relevant situation when entering the agreement.
The challenge for those invoking a MAC clause will be to show the consequential effect on the particular business and whether it will be enduring or terminal, rather than temporary or recoverable. They must also clearly demonstrate that, if those hurdles are met, the risks were not foreseeable if not specified in the clause.
A party will get significantly more certainty from a MAC clause expressed to be triggered on particular events with specific consequences.
Ongoing Deals
For contracts still under negotiation during the COVID-19 pandemic, it will be difficult for a party to establish that a MAC has occurred if the contract was negotiated with the full knowledge of the potential ramifications of the COVID-19 crisis on the global economy. Alternative remedies may be enhanced due diligence and negotiation of specific protections such as termination rights, purchase price adjustments and indemnities.
Conclusion
In order to assess the impact of COVID-19 on a particular business and its contractual relationships, a fact specific analysis is required. Parties are therefore advised to review the wording of the contractual terms, the nature of the business, the surrounding circumstances, and the impacts of COVID-19.
For any further information please contact Barbara Creed or any member in the Litigation & Dispute Resolution Belfast team.
Date published: 21 April 2020