The financial markets crisis has brought renewed focus to Material Adverse Change (MAC), or Material Adverse Effect (MAE), clauses. MAC or MAE clauses are present in virtually all merger and stock purchase agreements and are often a central feature in negotiations between the parties. MAC clauses are provisions that allocate risk in an interim period either between the date of the latest financials and the execution of a merger or acquisition agreement or between such execution and the closing of the transaction. Typically, a MAC closing condition allows either party to cancel the transaction in the case of, for example, a “change, event, circumstance or development that has or would have a material adverse effect on the assets and liabilities, financial condition or business of that party and its subsidiaries, taken as a whole.” The provisions then enumerate an expansive list of exceptions to this definition.
Changes in MAC Clauses Show a Reaction to Recent Markets Crisis
In years past, MAC clauses have been marked by ambiguity, and courts have largely refrained from clarifying the precise boundaries of their use other than to put the bar to invoking a MAC very high in requiring a material adverse effect on the earnings potential of a target company over a durationally significant time measured in years, rather than months. In the recent Hexion v. Huntsman decision, the Delaware Court of Chancery stated that it was “not a coincidence” that Delaware courts had never found a MAC to have occurred in the context of a merger agreement, and confirmed that the burden of proving a MAC is on the party seeking to avoid the agreement. The onset of the credit crunch in early 2008 has resulted in increasingly specific MAC clauses, as a number of parties have sought to better define their obligations under merger agreements in light of market uncertainties.
Additional Carve-Outs to the Definition of a MAC
The typical definition of a MAC will exclude certain events, such as changes in laws or economic conditions. A recent review of more than 40 transactions in 2008 valued at more than one billion dollars, however, indicates that most recent agreements have included a number of new and often deal-specific carve-outs as described below so that such events will not constitute or contribute to a MAC.
Changes in Commodity Prices
Negative impacts of the changes in commodity prices have been specifically excluded so that commodity price fluctuations cannot contribute to a MAC. For example, in the April 2008 Delta-Northwest merger agreement a “Material Adverse Effect” excluded “adverse Effects arising out of or relating to U.S. or global economic or financial market conditions, including…commodity prices and fuel costs...” The July 2008 merger agreement between InBev and Anheuser-Busch broadly excluded “effects resulting from changes in the economy or financial, credit, banking, currency, commodities or capital markets generally in the United States or other countries in which the Company conducts material operations or any changes in currency exchange rates, interest rates, monetary policy or inflation...”
Cost of Capital
Any increase in the costs of obtaining capital have been specifically excluded. The June 2008 stock purchase agreement between Safety Products Holdings and Honeywell International excluded “any increased cost of capital or pricing related to any financing for the transactions contemplated hereby…” The February 2008 merger agreement for the sale of Getty Images excluded “changes generally affecting…the economy or the credit, debt, financial or capital markets, in each case, in the United States or elsewhere in the world, including changes in interest or exchange rates…” Similarly, the merger agreement between Fertitta Holdings and Landry’s Restaurants excluded “any increase in the cost or availability of financing to Parent or MergerSub…”
Failure to Meet Projections
Virtually all of the deals reviewed explicitly excluded the seller’s failure to meet projections—internal or external—from the definition of a MAC. For example, the October 2008 merger agreement between Eli Lilly and ImClone Systems excluded “any failure by the Company to meet any internal or published industry analyst projections or forecasts or estimates of revenues or earnings for any period ending on or after the date of this Agreement…” The September 2008 agreement between Bank of America and Merrill Lynch excluded the “failure, in and of itself, to meet earnings projections, but not including any underlying causes thereof…” The Apax Partners-TriZetto agreement in April 2008 excluded “the failure of the Company to meet its projections or the issuance of revised projections that are more pessimistic than those at the time of this Agreement…” Similarly, the July 2008 agreement between Teva Pharmaceutical Industries and Barr Pharmaceuticals states that “any failure by the Company to meet internal projections or forecasts or third party revenue or earnings predictions for any period shall not be considered when determining if a Company Material Adverse Effect has occurred…”
Carve-outs from the MAC definition for disruptions in credit, equity and financial markets have been present in the most recent merger agreements. The Safety Products–Honeywell stock purchase agreement excluded “changes in, or circumstances or effects arising from or relating to, financial, banking, or securities markets…including…any disruption of the foregoing markets, [and]…any decline in the price of any security or any market index...” Additionally, the February 2008 merger agreement for the sale of Getty Images to ABE Investment set forth an exclusion from MAC for “the suspension of trading generally on the New York Stock Exchange or the Nasdaq Stock Market...”
Additional Risk-Allocating Provisions in Recent Agreements
Recent agreements also reflect a willingness on the part of sellers to accede to increased closing conditions, akin to MAC clauses, that allocate certain material risks to the selling company.
Debt Ratings Requirements
Several of the agreements reviewed contained provisions requiring the selling company to maintain a certain minimum debt rating. The September 2008 agreement between Constellation Energy Group and MidAmerican Energy Holdings Company contained a closing condition requiring that “On the Closing Date, all unsecured senior debt of the Company shall be rated investment grade or better with no less than a stable outlook by Moody’s Investor Service, Inc., Standard & Poor’s Ratings Group, Inc., and Fitch, Inc.” Likewise, the June 2008 agreement between Allied Waste Industries and Republic Services, Inc., required that “Republic shall have received written confirmation from the applicable agency that…the senior unsecured debt of Republic…will be either (i) rated BBB- or better by Standard & Poor’s and Ba1 or better by Moody’s, or (ii) rated Baa3 or better by Moody’s and BB+ or better by Standard & Poor’s.”
Limited Due Diligence Rights
The review also revealed novel uses of termination provisions to provide buyers with an opportunity to withdraw from the merger in the event the parties had not completed their due diligence efforts at the time the agreement was executed. For example, the Constellation Energy Group agreement provided the buyer with a “Limited Due Diligence Termination Right,” which allowed the buyer to terminate the transaction if it determined, at its sole discretion, that “the retail and/or wholesale businesses or assets of the Company, its Subsidiaries and the Company Joint Ventures taken as a whole have materially deteriorated.” The agreement further stated that “an adverse change in the net economic value of such businesses or assets in excess of $200 million from June 30, 2008 shall be deemed material.”
Several agreements conditioned the buyer’s obligation to consummate the transaction on the selling company’s ability to maintain a minimum EBITDA. For example, the February 2008 agreement between private equity firm Heller & Friedman and Getty Images contained a provision stating that “Consolidated EBITDA…for the twelve (12) month period ending March 31, 2008 (or, if the Closing Date shall occur on or after September 2, 2008, for the twelve (12) month period ending June 30, 2008) shall not be less than $300,000,000.”
No Bankruptcy Provisions
Finally, recent agreements have included as conditions to closing that certain parties to the agreement not be subject to any bankruptcy or insolvency proceedings. The Delta–Northwest merger agreement contains a specific condition to closing stating that “No proceeding shall have been instituted and not dismissed by or against [either party] seeking to adjudicate it bankrupt or insolvent, or seeking liquidation, winding up, reorganization, protection or other relief of it or its debts or any similar relief under any law relating to bankruptcy, insolvency or reorganization or relief of debtors...” If either party were subject to such a proceeding, the counter-party would not be obligated to effect the merger. The October 2008 Wells Fargo–Wachovia merger agreement included a similar provision as part of the conditions to closing, stating that neither Wachovia “nor any of its Significant Subsidiaries has filed for bankruptcy or filed for reorganization under the U.S. federal bankruptcy laws or similar state or federal law, become insolvent or become subject to conservatorship or receivership.”
Given the significant recent changes in drafting MAC clauses, as well as recent litigation regarding how they should be interpreted, it is now good practice to draft MAC provisions with greater specificity to minimize uncertainty in uncertain times.