Introduction
The coronavirus (Covid-19) pandemic has brought material adverse effect (MAE) clauses in mergers and acquisitions (M&A) transactions into renewed focus. In several announced M&A transactions, parties have sought to terminate or renegotiate agreements, and even commenced litigation based on MAE clauses.
MAE law and practice differs widely among key jurisdictions, such as the United States, France, Germany, Italy and the United Kingdom.
United States
What Is the Function of an MAE Provision in US M&A?
MAE clauses are always included in US M&A agreements. They are frequently used as a stand-alone closing condition and as a qualifier in the bring-down condition of the continued truthfulness at closing of representations made in the agreement. If an MAE occurred, or the representations would no longer be true and reasonably be expected to result in an MAE, a buyer may refuse to close and ultimately terminate the agreement.
How Is an MAE Typically Defined?
An MAE is broadly defined as any event that has, or would reasonably be expected to have, a material adverse effect on the target group’s business, assets, financial condition or results of operations, subject to certain carve-outs. It can also include the seller’s inability to consummate the transaction. Clauses typically do not quantify an MAE.
The finding of an MAE in the United States is subject to specific case law. Delaware, for example, has the most influential MAE case law. It applies a very high bar to finding an MAE, requiring that it must be “material when viewed from the long-term perspective of a reasonable buyer” and result in a durationally significant reduction in the target’s long-term earnings power.
In Akorn v. Fresenius Kabi (2018), the Delaware Court of Chancery provided some guidance on quantitative benchmarks that are likely to influence future decisions: a 40% decline in earnings as indicative of a stand-alone MAE, and a 20% decline in valuation as indicative of an MAE in the bring-down condition. These benchmarks are not dispositive, and cases are fact-intensive and may turn on qualitative evidence.
What Are the Typical Carve-Outs and Exceptions?
Typical carve-outs include effects from general economic conditions; conditions in the industry; changes in law or accounting principles; failure to meet projections; deal announcement; and certain force majeure events, e.g., war and natural disasters. These are also referred to as “systemic” risks that a buyer is expected to bear, except to the extent that certain carved-out risks affect the business disproportionately.
Which Elements Are Typically Negotiated?
While certain market standards have developed, the inability to consummate the transaction, the definition of “disproportionate” and “durational” effects and certain carve-outs that shift risk in an unacceptable manner are frequently up for negotiation. A buyer may not be prepared to accept the risk of earthquakes in a seismically active region, for example, or carve-outs for “known” conditions.
What Are the Current Trends and Issues?
Issues in deal terminations include whether, absent an explicit MAE carve-out, the risk of pandemics is captured in the general systemic carve-outs, e.g., general economic changes or changes in law.
The trend in carve-outs is to include pandemics, but buyers are increasingly demanding more specific closing conditions in addition to an MAE, such as no material loss of key customers or no material impact on earnings before interest, taxes, depreciation, and amortisation (EBITDA).
Committed acquisition financings are expected to continue to adopt the MAE definition of the M&A agreement.
France, Germany and Italy
What Is the Function of an MAE Provision in M&A in France, Germany and Italy?
In addition to being sometimes used as a stand-alone closing condition, an MAE or material adverse change (MAC) provision is frequently used in the warranty relating to the absence of material changes between the date of the latest accounts and the signing of the acquisition agreement. This warranty is occasionally repeated or “brought down” at closing. The MAE clause is, however, rarely used to qualify only the bring-down of the seller’s warranties at closing.
How Is an MAE Typically Defined?
An MAE is generally broadly defined as covering any event that has, or could reasonably be expected to have, a material adverse effect on the target’s business and, occasionally, on its future prospects. It is relatively uncommon (and very rare in Germany) to include the target’s inability to consummate the transaction in the definition of an MAE.
Owing to a lack of specific case law, the enforceability of an MAE provision depends on its drafting. This is why the MAE is frequently quantitatively defined as a percentage of the purchase price or a fixed euro amount, by reference to an accounting metric, such as EBITDA, or simply as a loss. A financial threshold may raise issues such as how amounts recovered from insurance, or provisions booked in the accounts regarding the MAE event, affect its calculation.
What Are the Typical Carve-Outs and Exceptions?
The majority of MAE provisions include one or more carve-outs. They usually relate to general economic, market and industry conditions, as well as changes in law and accounting principles. MAE provisions often capture only the target’s material subsidiaries or business units.
Occasionally, there are exceptions as to the absence of a disproportionate effect of these carve-outs on the target business.
Which Elements Are Typically Negotiated?
The financial threshold defining the MAE, as well as the carve-outs relating to changes in market and industry conditions (including whether such changes are limited to certain countries, and whether a disproportionate effect exception should apply) are generally heavily negotiated. In Germany, the consequences of enforcing an MAE clause, such as a termination fee, is also a topic for negotiation.
What Are the Current Trends and Issues?
At the beginning of the pandemic, the possibility of invoking an MAE clause in deals signed before the pandemic was a hot topic, especially in relation to broadly defined MAE provisions. The current market trend is to specifically exclude pandemics (including Covid-19) from MAE definitions as a pre-existing condition. In sectors directly affected by the pandemic, buyers may seek to obtain specific closing conditions covering the consequences of the pandemic on the target.
Until the syndicated and leverage loan markets are more active again, it is unclear whether MAE provisions will be widely used in the financing documentation.
United Kingdom
What Is the Function of an MAE Provision in UK M&A?
An MAE clause in private treaty transactions is a closing condition giving the buyer rights (including termination) where adverse events occur that render the transaction no longer viable on the agreed terms. In UK public takeovers, the ability to invoke a material adverse effect requires an even higher threshold akin to contractual frustration. For example, in the aftermath of 9/11, the invoking of MAE by WPP Group PLC following its offer for Tempus Group PLC, and during Covid-19 by Brigadier following its offer for Moss Bros Group PLC, were both rejected.
How Is an MAE Typically Defined?
MAEs include any fact, matter or event which could or could reasonably be expected to materially and adversely affect the business, assets and operations of the target group.
What Are the Typical Exceptions?
Exceptions include:
- • Any adverse change or event arising from:
- Business or economic conditions
- National, international, political or social conditions
- Changes in markets or laws or their interpretation
- A failure to meet any projections, forecasts or revenue predictions
- Changes that apply to industries or markets in which the group operates
- Matters that have been disclosed or arise from the announcement of the transaction or a change of control of the target.
Which Elements Are Typically Negotiated?
Negotiations will focus on the subjective/objective interpretation of the MAE clause and whether the clause is forward-looking and triggered by events that could reasonably be expected to have material adverse effects. Other areas of negotiation typically include group/individual application and financial thresholds.
What Are the Current Trends and Issues?
In private treaty transactions, MAE clauses are heavily negotiated but seldom triggered or litigated and mostly seen in larger transactions with an international dimension. Limited conditionality is borne out of the sellers’ focus on agreeing a certain funds deal, with limited opportunity for the buyer to terminate once the deal is signed.
Leading case law’s high watermark in Grupo Hotelero Urvasco v. Carey Value Added SL (2013) requires that adverse change be: i) material; ii) not temporary; and iii) financial condition is determined by reference to information covering the relevant period. Parties exercise remedies upon a breach of a material term and instead utilise MAE to negotiate changes/pricing. Covid-19 has given rise to some buyers terminating acquisition agreements, resulting in potential litigation, although UK and supra-national regulators have urged caution before the exercise of remedies, and reputation remains a key consideration.
