DealLawyers.com Blog

From Matt Farber: Since the beginning of the financial crisis, news columns and law firm memos have given much attention to material adverse change (MAC) clauses. No doubt, such prompt attention followed the substantial litigation MAC clauses garnered after many disappointed buyers attempted to exit. For a new transactional lawyer, therefore, it may be helpful to learn about MAC clauses, including their purpose, where they appear in a contract, and their panoply of risk-allocating language.

A MAC (also known as a Material Adverse Event or MAE) clause is a contract provision that assigns risk between contracting parties. Since there is often a period between the signing of a merger agreement and its closing, one of the parties must bear the risks of adverse events to the target company during this time. If a qualifying adverse event injures the target company, then the buyer may refuse to close the deal or “walk.” Shira Ovide of the Wall Street Journal summarizes this device nicely: “The clause says, in essence, that a buyer can spike an acquisition offer if the business of the company being acquired has seriously blown up since the acquisition agreement was stuck.”

But, what exactly is an “adverse event?” The answer is deal specific; nevertheless, a MAC is generally premised as an “effect, event, development, or change that, individually or in the aggregate, is materially adverse to the business, results of operations or financial condition of the company and its subsidiaries, taken as a whole.” From this basis, parties negotiate certain exclusions, known as “carve-outs.” These can be found in the MAC clause’s lead-in or within the MAC definition itself. Contracting parties generally allocate market and systemic risks to the buyer and allocate to the seller those closing risks that harm the target disproportionately.

The buyer’s ability to exit the deal is curtailed by MAC clause exceptions, which are as varied as are the deals that contain them. Broadly, buyers will argue for a broad MAC clause that allows them to terminate the agreement when adverse events make the acquisition unattractive. Sellers, on the other hand, will attempt to negotiate a narrow MAC clause to displace the closing risks of the target business. A few deal terms that modify the clause include shifting the burden of proof of the absence of a MAC to the seller, forward-looking standards (the pre-closing event has, or is reasonably likely to have, a post-closing effect), and adverse events that are not durationally significant.

Within an agreement, a MAC clause may be found as a condition, representation, or both. As a closing condition, a MAC clause allows the buyer not to close the transaction if the target business suffers a MAC between a baseline date (such as signing) and the date of closing. As a seller representation, a MAC clause states that the target business has not suffered a MAC between the baseline date and closing, plus a closing condition that allows the buyer to walk if such a representation is false at the closing date. If such an event does occur, the MAC clause will fail to be “brought down” as a closing condition. For example, in the Genesco/Finish Line merger agreement, the parties defined their MAC with carve-outs as follows:

“Company Material Adverse Effect” shall mean any event, circumstance, change or effect that, individually or in the aggregate, is materially adverse to the business, condition (financial or otherwise), assets, liabilities or results of operations of the Company and the Company Subsidiaries, taken as a whole; provided, however, that none of the following shall constitute, or shall be considered in determining whether there has occurred, and no event, circumstance, change or effect resulting from or arising out of any of the following shall constitute, a Company Material Adverse Effect: (A) the announcement of the execution of this Agreement or the pendency of consummation of the merger (including the threatened or actual impact on relationships of the Company and the Company Subsidiaries with customers, vendors, suppliers, distributors, landlords or employees (including the threatened or actual termination, suspension, modification or reduction of such relationships)); (B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (C) any change in applicable Law, rule or regulation or GAAP or interpretation thereof after the date hereof, so long as such changes do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (D) the failure, in and of itself, of the Company to meet any published or internally prepared estimates of revenues, earnings or other financial projections, performance measures or operating statistics; provided, however, that the facts and circumstances underlying any such failure may, except as may be provided in subsections (A), (B), (C), (E), (F) and (G) of this definition, be considered in determining whether a Company Material Adverse Effect has occurred; (E) a decline in the price, or a change in the trading volume, of the Company Common Stock on the New York Stock Exchange (“NYSE”) or the Chicago Stock Exchange (“CHX”); (F) compliance with the terms of, and taking any action required by, this Agreement, or taking or not taking any actions at the request of, or with the consent of, Parent; and (G) acts or omissions of Parent or Merger Sub after the date of this Agreement (other than actions or omissions specifically contemplated by this Agreement).

Cases

– In re IBP, Inc. Shareholders Litigation, 789 A.2d. 14 (Del. Ch. 2001)
– Frontier Oil Corp. v. Holly Corp., C.A. No. 20502 (Del. Ch. 2005)
– Genesco, Inc. v. The Finish Line, Inc., No. 07-2137-II(III) (Tenn. Ch. 2007)
– Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (2008)