A material adverse change (MAC) is a common term in merger and acquisition agreements. The term describes a change or event that, if realized, could have a material negative impact on the parties to the transaction (mainly on the acquiree company). MAC clauses stipulate which events entitle the buyer to cancel the transaction, provided they materialized between the agreement’s signing date and the transaction’s consummation.
In the context of M&A transactions, it is customary for all parties involved to try to take the gamut of factors into account before signing an agreement. Typically, there exists an interim period, often lengthy, between agreement signing and final transaction completion. During this period, the parties work to obtain the requisite approvals for executing the transaction, while the buyer is exposed to the risk that a MAC event might materialize in the acquiree company. Unforeseeable MAC events present an unanticipated risk that can fundamentally alter the transaction terms, rendering it unfavorable for the buyer. The buyer may not have initially considered such risks, which can significantly impact the viability of the deal.
The main purpose of MAC clauses in M&A agreements is to protect the buyer precisely from those unforeseeable MACs. These clauses enable the release of the buyer from the transaction when its terms have changed materially for the worse during the interim period.
Defining MAC Events
The COVID-19 pandemic marked a significant milestone in the wording of MAC clauses. The unprecedented circumstances resulting in MAC events compelled parties in numerous transactions to make compromises that led to financial losses. Inadequately worded MAC clauses failed to account for the risks associated with a pandemic, necessitating revisions and compromises. Lessons learned from that period still resonate today, as companies prioritize the precise wording of MAC clauses. At the same time, the courts have refrained from adopting an all-encompassing approach when adjudicating cases that involve MAC clauses. Therefore, companies today place far greater emphasis than in the past on the wording of a MAC clause so that it will provide protection to the specific parties even under highly unusual circumstances.
The MAC’s standard definition is usually comprised of the following elements:
- A general definition that stipulates what constitutes a material adverse change pursuant to the agreement. This should include a definition of “materiality” and a specification as to how the change would impact the company, whether broadly or narrowly.
- A definition of carve-outs that, although they essentially constitute a material adverse event or effect, will not be considered MACs. For example, various states of emergency, such as a war or pandemic, any adverse impact on the entire specific market in which the company operates, etc.
- “Carve-outs exclusions”,stipulating which carve-outs will be deemed MACs. For example, if the exceptional situation’s impact on the acquiree company is disproportionate to the impact on all other companies in the relevant market.
During negotiations, it is crucial to formulate a comprehensive definition of MAC that encompasses relevant situations, including exceptional circumstances specific to the transaction and the acquiree company’s market. This ensures thorough coverage and alignment with the unique dynamics of the operating market.
A well-drafted MAC clause in an agreement is paramount to avoiding uncertainty and potential disputes between parties.
By providing clarity and addressing potential issues upfront, it can even preempt the need for future litigation. To achieve optimal wording, it is important to identify and differentiate between the different interests of the parties (the sellers and the buyers) and to word the definition so that it benefits the relevant represented party. When drafting MAC clauses, it is essential to consider the relevant market and specific characteristics of each party involved in the transaction. This includes aspects discovered during legal and accounting due diligence examinations. Such attention to detail ensures the clauses accurately reflect the parties’ unique circumstances.
For example, when dealing with a company reliant on key employees for its growth, it is prudent to include a provision in the MAC clause that considers the departure of these individuals during the interim period as a material adverse change. This helps safeguard the buyer’s interests and ensures the clause addresses the specific circumstances of the transaction.
MAC-Related Litigation
There is no legal definition to the term MAC. Rather, it is a contractual term that the parties involved in the transaction create. As a result, parties typically aim to resolve MAC-related disputes through negotiation rather than resorting to litigation. By establishing a clear and comprehensive definition of MAC, the parties can facilitate the resolution of such disputes through direct communication and agreement.
If the parties to a transaction are unable to resolve the dispute among themselves, and one of them opts to litigate, the courts will prefer not to adjudicate the dispute and will instruct the parties to reach a solution by way of compromise, to the extent possible.
In instances in which the parties fail to reach a compromise and the court must intervene and adjudicate, its approach is to examine each case on its merits, since the definition of “MAC” and the circumstances of the event’s occurrence vary from case to case. The few courts that have addressed the issue (mainly in the United States) have concluded that, in addition to a specific examination of each case, when examining the material adverse change (MAC) event that occurred, it is possible to adopt general guidelines that will serve as “guidance” rather than legal precedent.
United States – General Guidelines for Examining MAC Events
US case law has addressed the issue of MAC events a few times. Moreover, over the years, it has developed general guidelines for examining the materialization of MAC events.
Court rulings have indicated the need for cumulative proof to substantiate the materialization of a MAC event:
- The event constitutes a material and comprehensive deterioration (the acquiree company’s profits have dropped by at least 40%).
- The event is likely to affect the company’s value and/or its profit potential over a long period, at least one year.
Please note that these are “general guidelines.” Therefore, even upon fulfillment of these two criteria, the court will not necessarily rule a MAC event has materialized and cancel the transaction, but will also examine additional parameters pertaining to the specific transaction.
For example, in the 2018 Akorn case, a Delaware court made a landmark ruling allowing a buyer to invoke the MAC clause and cancel an acquisition due to an 86% profit decline. The court characterized the decline as the acquiree company “fell off a cliff.” The court’s examination established that both of the above criteria were proven, indicating that the company’s profits deteriorated over a lengthy period. Nevertheless, critiques of this ruling say it is possible that what caused the court to rule that the buyer could cancel the transaction was not the fulfillment of the criteria per se, but, rather, primarily the evidence of mala fides on the part of the sellers in the case.
The courts’ threshold for canceling a transaction due to the materialization of a MAC event is apparently quite high. To minimize uncertainties and avoid court disputes, it is crucial to establish maximum clarity and certainty between the parties by carefully defining MAC clauses in each agreement. This proactive approach allows the parties to address and resolve MAC-related issues internally, fostering smoother transactions and reducing the need for the courts’ intervention.
***
The firm’s Corporate department is at your service for questions and counsel regarding Mergers & Acquisitions and other transactions.
For further information please contact Adv. Sagi Gross.