Material Adverse Change Uncertainty

Covering unwelcome uncertainties of the future, yet inherently uncertain and ambiguous by themselves, material adverse change/effect (‘MAC’) clauses have evolved into important risk-allocation mechanisms that are commonly included in high-profile financing and mergers and acquisitions (‘M&A’) deals. They typically allow lenders or buyers to either terminate an agreement without cost or penalty, or leverage the other party into renegotiating the agreement. When the prospects for business are dark, desperate lenders and buyers often seek to rely on MAC clauses to save their economic interests.

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 UK, a recent example of an unsuccessful exit from a £22.6 million acquisition deal involved the Offer by Brigadier Acquisition Company Ltd for Moss Bross Group Plc. A current MAC case in the English High Court is Travelport v. Wex Inc., regarding abandoning a $1.7 billion acquisition deal. In the US, the Delaware Court of Chancery is the epicentre of the filed MAC cases: Tiffany & Co. v. LVMH; 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. 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 a recent article, ‘Material Adverse Change uncertainty: costing a fortune if not corporate lives’ (forthcoming in the Journal of Corporate Law Studies), I examine the uncertainty surrounding MAC clauses under English law, both in debt finance and in M&A deals, 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:

1. for increasing the practical significance of MAC clauses by the contracting parties as a ground for renegotiation or termination of the deals, given the current destabilising market events; 
2. that the Delaware MAC principles, such as on burden of proof, magnitude of change, knowledge, or duration of the adverse events, 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 (debt finance and M&A); and
3. that, while the principles of MAC clauses established by the previous case law, such as on knowledge, magnitude, or durations of the adverse events, 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 analyses 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, 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 MAC. In the context of M&A, Rule 13.1 of The City Code on Takeovers and Mergers considerably restricts the bidder’s subjective determination option for the occurrence of MAC. 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. In the article 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 by the lenders and buyers. 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 the international or domestic markets in a way that could be detrimental for a financing deal) will also become more widespread as an ex-postprotection mechanism.

The article then identifies and analyses 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/unforeseen events or also known/foreseen events). I argue that these inconsistencies have arisen as a result of the English court in Grupo Hotelero v. Carey (MAC in a loan agreement) relying on a Delaware case, IBP Inc. v. Tyson Foods  (MAC in M&A agreement), for the analysis of MAC in a loan agreement, without providing justifications as to the applicability of IBP’s principles to Grupo Hotelero and, equally importantly, without an explanation of the applicability of an analysis of MAC in M&A to MAC in debt finance. The basis for this criticism is thus 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 individual case and to analyse MAC clauses without a ‘one-size-fits all’ approach, in relation to the knowledge test, magnitude in the decrease of the company’s value or performance, duration of the adversity, and the other aspects relevant for the determination of MAC. There is no overarching model for the correct application and interpretation of the MAC clause in debt finance or M&A. 

The comparison demonstrates that:

1. the existing inconsistencies of MAC’s application under English and Delaware case law precede Akornand Boston Scientific; 
2. Delaware MAC principles had a direct and indirect influence on the development of MAC under English law; and
3. 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. 

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.

Narine Lalafaryan is a PhD candidate at the Faculty of Law, University of Cambridge, and a Life Member of Clare Hall college, University of Cambridge.

A version of this post first appeared on The CLS Blue Sky Blog.