August 7, 2017

Delaware: MAE Clauses in a Commercial Contract

This Shearman & Sterling memo summarizes the Chancery Court’s recent decision in Mrs. Fields Brands v. Interbake Foods – in which Chancellor Bouchard interpreted a termination right based on a “Material Adverse Effect” clause in a license agreement.  The memo notes that the Chancellor applied the same tests to the exercise of an MAE-based termination right as those that would apply in an M&A transaction:

Even though the license agreement did not involve a merger or acquisition, in analyzing the undefined term “material adverse effect,” Chancellor Bouchard applied the Court’s three-prong MAE test from In re IBP Shareholder Litigation, which construed an MAE condition as a backstop protecting the acquirer from:

– the occurrence of unknown events,

–  that substantially threaten the overall earnings potential of the target,

–  in a durationally significant manner.

Under Delaware law, an adverse change must be consequential to a company’s long-term earnings power over a commercially reasonable period in order to be durationally significant.  Although Chancellor Bouchard said that the period for assessing durational significance might be shorter in the context of a commercial contract than in an acquisition agreement, he found that none of the three conditions for invoking an MAE termination had been satisfied.

John Jenkins