Mergers And Acquisitions: Material Adverse Change
The recent turmoil in credit markets has caused acquirers and their lenders in several high-profile pending merger and acquisition transactions to seek ways to withdraw from or renegotiate signed deals, because the expected financing either is not available or available only on terms that substantially reduce the deal’s economic attractiveness. Agreement provisions are being scrutinized — not only for their absolute enforceability but for the leverage they provide to renegotiate the deal. Sellers, by contrast, are reviewing agreements to seek to hold acquirers to the deal terms.
This trend will affect satellite industry transactions, making an understanding of deal protection techniques critical.
Merger and acquisition agreements include “conditions to closing” provisions, the failure of which to occur relieves the beneficiary party from its obligation to close the transaction and which tie into the termination rights elsewhere set forth. Conditions to closing include “material adverse change,” or MAC, clauses that operate to excuse the acquirer from closing the transaction if a material adverse change, as defined in the agreement, occurs to render the seller less valuable than it was before the MAC occurred. A variant is the “material adverse effect,” or MAE, clause.
Even with sophisticated parties and advisors, the MAC clause often is used as a residual bucket for unforeseen events. A boilerplate, stand-alone version of the clause is inserted with relatively standard definitions of what constitutes a MAC and of “carve outs” — events specifically excluded from the MAC definition — the occurrence of which will not relieve the beneficiary party from its obligation to close. The acquirer may be ill-served by a perfunctory drafting approach, because case law on MAC clause interpretation is highly fact-specific and suggests that courts are loath to allow a MAC to excuse a party from closing unless its right to do so based on the language is very clear. When the language is ambiguous, a court may review evidence of the parties’ intentions when entering into the agreement and may be even less likely to enforce the MAC clause if the due diligence process should have put the acquirer on notice of the potential event now being asserted as a MAC.
For example, a typical MAC clause might define a MAC as “any change that is or would be expected to have a materially adverse effect on the assets, liabilities, operations, financial condition or prospects of the seller.” Carve outs may include macroeconomic downturns, industry-wide events and legal and regulatory changes that will not excuse closing, with provisos to the carve outs to stipulate that the seller must not be disproportionately affected by the event for the carve out to apply. Of course, an event not being one of a long list of carve outs increases the chances that a court will decide it was intended to be a MAC.
While the use of actual, quantifiable metrics as MAC definition benchmarks is not common, it should be considered as a bright-line test that a court would be more likely to enforce (and which would therefore also discourage litigation) and which would provide certainty for the parties, much like a “stop loss” order for a trader. The downside to quantification of events constituting a MAC, of course, is that an event falling short of the metric will be held not to constitute a MAC.
Moreover, a perfunctory approach to MAC drafting wastes a valuable opportunity to expose what the party bearing the burden of the obligation really considers a meaningful pre-closing risk in a way that due diligence and disclosure schedule exceptions may not. A seller that does not push back on expressly defined MAC events may be showing confidence that none will occur. Seller pushback is even more valuable; judicious negotiation by the acquirer may provide valuable information as to what the seller fears is a realistic possibility.
Clearly, assertion of a MAC involves a complex calculus for acquirer, lender and seller. Even though courts may be loath to excuse a party from closing based on a MAC, a non-frivolous claim opens the door to possible excused performance. In such a case, the seller may be under intense pressure to renegotiate. Possible solutions range from withdrawal from the transaction to a lower purchase price, negotiation of additional post-closing protections such as purchase price adjustments, staged payment of the purchase price upon the passing of performance or temporal milestones, or other risk-shifting measures.