The Cost of Uncertainty About Material Adverse Changes

Material adverse change/effect (“MAC”) clauses have evolved into important risk-allocation mechanisms that are commonly included in high-profile mergers and acquisitions (“M&A”) and financing deals. They typically allow lenders or buyers to either terminate an agreement without cost or penalty or renegotiate the agreement from a position of strength. When the prospects for business are dark, desperate lenders and buyers seek to rely on the ex-post triggering function of MAC clauses to avert disaster.

The uncertainty caused by COVID-19, exacerbated in the UK by Brexit, has forced many market participants to re-examine their deals. While some have managed to adjust, others have attempted to exit by triggering a MAC. In the U.S., the Delaware Court of Chancery is scheduled to consider a number of MAC cases: Level 4 Yoga LLC v. CorePower Yoga LLC; Juweel Investors Ltd. v. Carlyle Roundtrip LP et al; Snow Phipps Group LLC v. KCAKE Acquisition Inc.. (Simon Property Group Inc. v. Taubman Center Inc. has been filed in the State of Michigan.) In other Delaware cases, Bed Bath & Beyond Inc. v. 1-800-Flowers.com; Forescout Technologies Inc. v. Ferrari Group Holdings; and SP VS Buyer LP v. L Brands Inc., the parties settled before trial. In the UK, a recent example of an unsuccessful exit involved the Offer by Brigadier Acquisition Company Ltd for Moss Bross Group Plc. An upcoming case in the High Court in the UK is Travelport v. Wex Inc., regarding abandoning a $1.7 billion acquisition deal.

In a recent article, “Material Adverse Change uncertainty: costing a fortune if not corporate lives,” I examine the uncertainty surrounding MAC clauses under English law, both in M&A and in debt finance, after Delaware’s ground-breaking Akorn v. Fresenius case (“Akorn”) and the more recent (although less significant) Channel Medsystems v. Boston Scientific (“Boston Scientific”). In the article, I argue:

  • for increasing the practical significance of MAC clauses as bases for renegotiating or terminating, given the current destabilizing market events;
  • that Delaware MAC principles could help resolve the English MAC uncertainties, subject to considering the specifics of MACs in the two legal systems and in the two legal areas (M&A and debt finance); and
  • that, while the principles of MAC clauses are relevant for the upcoming cases, there is no universal model for correctly construing MAC clauses in M&A or in debt finance.

To this end, the article analyzes the essential features of MAC clauses in debt finance and M&A, while simultaneously highlighting the differences of their application in various types of debt finance (e.g. term loans, revolving loans, syndicated loans v. bonds), and, for certain cases, between debt finance and M&A. One such difference relates to the distinctive nature of bonds, which do not commonly include MAC clauses due to a variety of reasons, such as the public nature of bond instruments, the bondholder coordination problem, and the established market reputation and good credit rating of the borrowers. Other differences arise from the contractual modification option for determining the occurrence of a MAC. In the context of mergers and acquisitions, Rule 13.1 of The (UK) City Code on Takeovers and Mergers considerably restricts the bidder’s subjective determination of whether a MAC has occurred. In debt finance, however, under English law MAC clauses can contractually be modified to involve either an objective or a subjective determination test by the lender.

I further argue that, due to the uncertainty in the market and due to the pre-COVID covenant-lite trend in leveraged credit agreements, lenders might be inclined to make the terms of the financing tighter. Hence the renegotiation function of MAC clauses will be relied on more. This will also affect the lenders’ willingness to grant waivers and, at the same time, the lenders’ hedging of their economic risk via credit default swaps. The inclusion of “market MAC” clauses (e.g. market events affecting, for example, the international or domestic markets in a way that could be detrimental for a financing deal) will also become more widespread as an ex-post protection mechanism.

The article then identifies and analyzes the unresolved inconsistencies in the application of MAC clauses both in M&A and debt finance between English and Delaware law. The main inconsistency is in the application of the “knowledge test” that can prevent the exiting party from relying on the MAC clause (i.e. whether the MAC clause can be relied on only in relation to unknown or unforeseen events). I argue that these inconsistencies have arisen as a result of the English High Court’s reliance in Grupo Hotelero v. Carey on a MAC in an M&A case from Delaware case law, IBP Inc. v. Tyson Foods, for the analysis of MAC in a loan agreement. The basis for this criticism is the way the court construed its legal analysis, not the fact that it referred to Delaware case law.

To address the inconsistencies in English case law I take a comparative methodological approach (providing a number of justifications for its appropriateness) and refer to the Delaware MAC judicial principles of Akorn and Boston Scientific for a possible resolution. The solution seems to be to respect the contractual modification of the MAC language in each case and to analyze MAC clauses without a “one-size-fits all” approach, in relation to the knowledge test, magnitude in the decrease of the company’s value, duration of the adversity, and the other aspects relevant for the determination. The comparison demonstrates that:

  • the existing inconsistencies of MAC’s application under English and Delaware case law precede Akorn and Boston Scientific;
  • Delaware MAC principles had a direct and indirect influence on the development of MAC under English law; and
  • legal principles of Akorn and Boston Scientific in certain circumstances might contribute to the development of the MAC’s construction and the resolution of some of the uncertainties surrounding it under English law.

In this respect I argue that a direct transplanting of MACs is undesirable, as it seems to ignore the different analytical hallmarks of the legal systems and also the commercial reality of MAC in distinct areas. Furthermore, there is no universal model for the correct application of MAC clauses in M&A or in debt finance.

The article concludes that, in the current environment, deal renegotiation is inevitable, while exiting via MAC appears comfortable: an option that will be attempted by some of the distressed parties. The costs and risks of abruptly terminating such multi-billion-dollar deals, however, will be significant, if not devastating.

This post comes to us from Narine Lalafaryan, a Hogan Lovells Scholar and PhD candidate at the University of Cambridge, Faculty of Law. It is based on her recent article, “Material Adverse Change uncertainty: costing a fortune if not corporate lives,” available here.

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