Understanding Material Adverse Effect Clauses
July 25, 2022
In merger and acquisition (M&A) agreements, invariably, a clause will be inserted that concerns any material adverse change (MAC) in the target business that may warrant revisions to the original deal or even cancellation of the whole transaction. Another term for this is the material adverse effect (MAE).
MAC clauses protect the buyer after the merger agreement is signed and before the transaction is concluded, often months or years later, depending on the amount of due diligence required. A MAC trigger could arise from any number of changes in the target entity.
For instance, the CEO may abruptly leave and take top management, or the target business could lose a contract that comprised most of its revenue. Any number of events that cause the target entity to lose value could bring the MAC opt-out up and center.
If you’re eyeing a merger or acquisition or involved in one and a material adverse event occurs, in or around Overland Park, Kansas, contact the Coppaken Law Firm. We can help you draft merger agreements that protect you as a buyer or seller, and we can help if an adverse event threatens the survivability of the agreement. We have advised and helped clients from family businesses to Fortune 500 Corporations for a long time.
We also proudly serve clients in Kansas City, Missouri, and throughout Johnson County, Kansas, and Jackson County, Missouri.
What Is a Material Adverse Change?
A material adverse change occurs – or is discovered – during the time between the acquisition agreement signing and the eventual closing of the transaction. A few examples were given above, with the departure of key people who are not easily replaceable or with the loss of a contract that diminishes the future profitability of the target company.
Generally speaking, a material adverse change will affect the target business and its subsidiaries concerning their:
Liabilities and assets.
Intellectual property and patents.
Market access, including foreign markets.
Licenses and leases, such as mining licenses, spectrum licenses, and land leases.
What Is a Material Adverse Change Clause?
A material adverse change clause can be used by buyers and sellers to protect their interests in the closing of a deal. Sellers can so word the clause that it effectively protects them from seeing the buyer try to back away or change the terms of the deal when, during their due diligence, they discover factors that may affect the operations or profitability of the merged entity. Buyers, of course, will resist these restrictive clauses.
Buyers also can fashion material adverse change clauses that give them the right to alter the terms of the deal more favorably if they discover events or conditions that lower the value of the transaction. The clause may even give them the right to terminate a deal.
Benefits of a MAC
Material adverse change clauses are so ubiquitous that most loans also contain such clauses because they protect the lender against losses if the loan applicant suffers an event that makes repayment of the loan less likely. The main benefit of a MAC is protection.
The benefit of an M&A to sellers is that a properly worded MAC clause will shield them against reimbursing the buyer even if the buyer discovers misconceptions by the seller. The misconceptions must rise to the level of a material adverse change to trigger any action against the deal or the seller.
The benefit to buyers is that a properly worded MAC clause can provide a back door to exit the deal or at least renegotiate the terms to account for the material adverse effect.
Hurdles to Enforcing a MAC Clause
The biggest problem with enforcing a MAC clause is proving that an adverse event or condition calls for changes or an end to the proposed transaction. Courts have long been reluctant to grant buyers the right to back out of a deal because of a MAC.
In fact, in Delaware, where many of America’s largest corporations are registered, the courts have never granted a MAC lawsuit. Even during the Great Recession, when target companies’ bottom lines kept falling, the courts still held buyers responsible to complete the deal.
A buyer who wants out of an M&A because of a MAC assumes the burden of proof in a court of law. To substantiate a claim under a MAC clause, the adverse event or condition must be one that will last for years, not just for months – it must be long-term, in other words. The triggering event, condition, or discovery must have been unforeseeable at the time the deal was signed. These two factors represent a fairly high legal hurdle.
That being said, a buyer is certainly better off with a carefully crafted material adverse change clause, and if it spells out what it considers triggering events or changes, all the better for bringing the matter before a court.
Turn to Knowledgeable Legal Guidance
At Coppaken Law Firm, we have the experience, knowledge, and resources necessary to assist clients in how businesses operate and the challenges they face. If you’re considering a merger or acquisition, or are about to be involved in one either as a buyer or seller, contact the Coppaken Law Firm immediately. We can guide and advise you in every step of the process to protect your rights and interests. We proudly serve clients in Kansas City, Missouri, and throughout Johnson County, Kansas, and Jackson County, Missouri.