MATERIAL ADVERSE CHANGE PROVISIONS (“MAC”) contractual provisions act as an all-purpose out for a buyer whose inclination to conclude the deal has evaporated for reasons that may or may not be connected to the MAC. This article shall describe the uses and abuses of this provision and how the intelligent Seller will seek to avoid them-and the intelligent buyer always seek to obtain them.
MACs are standard in the closing provisions/representations and warranties attendant to most mergers or private equity buyouts. But they have a checkered history in terms of a buyer's ability to actually use them to avoid a deal. Recently, MAC Provision litigation may be heating up, what with Sallie Mae feeling the sting of buyers saying "something suddenly came up and, therefore, we can't do this deal." (Accredited Home Lender had also felt that sting, but its deal with PE firm Lonestar Fund closed on October 12 after a little saber rattling.) The usual argument centers around whether the event in the MAC is material enough to allow abandonment of the deal or was already known by the buyer before the deal was made.
Your basic MAC Provision normally is similar to the following:
Material Adverse Change. From the date of the Financial Statements to the date hereof, neither Seller shall have suffered any change which has a material adverse effect (whether or not such effect is referred to or described in any Schedule) on the business, prospects, financial condition, assets, reserves or operations of the Sellers taken together.
The point of the key word, “material” is to prevent a buyer from walking away from a deal in response to minor events that don't impact the seller's business; but it still offers the buyer a way out when something really serious does impact the seller’s business. That is why there is renewed interest in MAC Provisions these days. The credit crunch and sub-prime debacle have made a lot of financial assets that are part of pending deals less attractive than earlier, so one can assume that some buyers will be trying to invoke MAC clauses.
Most acquisitions agreements will define material adverse change (sometimes they will call it "material adverse effect" or “MAE”), but the devil being in the details, the term "material" is not generally defined. By historical practice, it is assumed that everyone knows a “material change” when they see one. The failure or inability to define "material" has led to much litigation, as buyers seek to exercise these clauses and sellers deny that circumstances warrant such action. And by and large, courts are prone to support culmination of the transaction minus truly radical changes in the landscape of the financials that would not have been easily predicated by the buyer.
The most recent seminal case in this regard is IBP, Inc. v. Tyson Foods, Inc., 789 A.2d 14 (Del. Ch. 2001), which ordered specific performance of an acquisition after the buyer balked based on the MAC Provision. The court conducted the following analysis:
Despite a significant drop-off in earnings during the seller’s first quarter, the Court found that, when examined in connection with the cyclical nature of the seller’s business and its consistently fluctuating economic performance over time, the drop-off did not indicate a material change in the financial situation of the seller over a long period.
In addition, rather than judging the buyer’s dealings under the standard of a reasonable purchaser, the Court subdivided the reasonableness standard into that of an acquirer looking at the long-term prospects of the business and a short-term speculator. The Court reasoned that a short-term speculator may well consider a first-quarter drop-off in earnings as “material” while a long-term acquirer would need to look at the seller’s earnings over a long period of time: “a MAC embraces a development that is consequential to a company’s earning power over a commercially reasonable period, measured in years rather than months.” (Footnote omitted).
The Court’s analysis leaves the interpretation of a MAC clause dependent on the nature of the buyer. For example, the MAC clause in a highly leveraged transaction (which is dependent on financing) is more likely to be judged on a short-term basis.
So when it comes to MAC Provisions, it tends to be a seller's market.
The wise seller can create provisions that can avoid having a deal disappear due to unforeseen changes assuming the buyer is willing to be flexible during negotiations.
A well-drafted MAE clause should provide exceptions to a MAE to account for unavoidable circumstances such as changes to general industry conditions or natural disasters." Many MAC Provisions now include long lists of events that will not qualify as material. In fact, the exceptions to the MAC Provision (or carve-outs) threaten to swallow the MAC Provision itself, with so many exceptions being grafted on to it that a buyer would be hard-pressed ever to meet any threshold for walking away. Obtaining good legal advice as to the crafting of MAC provisions is essential for both the buyer and the seller…and may also flush out some hidden motivations of the buyer.
A deal that is too lop sided can easily be overturned by the courts due to lack of consideration. See our article on Contracts. Nevertheless, for buyers, an artfully worded MAC clause can, at the least, avoid buyer’s remorse predicated on remarkable events immediately after execution of the document. It should be a part of every deal from the buyer’s point of view and limited as much as possible from the seller’s point of view.