Most acquisition agreements, such as stock purchase, merger or asset purchase agreements, contain several closing conditions that must be satisfied by the respective parties prior to closing the transaction. One such condition is the “material adverse effect” or “material adverse change” (hereafter, “MAC” – courts use the terms interchangeably and use the same approach for change and effect clauses).
Typically, a MAC clause will specify a date – often that of the party’s latest balance sheet – and hold that the party or its subsidiaries cannot have suffered an event or occurrence which may be deemed to be a MAC. A Material adverse effect is commonly defined as a “material adverse effect on the business, assets (including intangible assets), financial condition, prospects, or results of operations of such party and its subsidiaries, taken as a whole,” with slight variations thereof. In some instances, MAC definitions – for purposes of determining whether the condition is satisfied – contain certain carve-outs. Such carve-outs include for general business circumstance, economic conditions and downturns in the party’s industry.
Sellers include these MAC carve-outs to narrow the circumstances under which the buyer is entitled to walk away from the deal. Buyers attempt to use MAC clauses as a way of not being forced to consummate the deal.
Generally speaking, a MAC clause places general market or industry risk on the buyer and risks specific to the target company on the seller. For example, a buyer may become aware that, due to recent industry downturns, a seller’s projected revenues will be much lower than those previously provided to the buyer. In this situation, the buyer would attempt to proceed with exercising its right to terminate the acquisition agreement under a MAC clause. In response, the seller may take the position that a carve-out to the MAC relating to industry-wide events applies and, as a result, the buyer is not entitled to exercise its termination right. What will be crucial for this example are the carve-outs previously noted. The carve-outs will predominately effectuate whether or not a MAC has occurred, which in turn will determine if the buyer can walk away from the acquisition agreement.
Courts have refrained from adopting a bright-line rule for determining whether a MAC has occurred and, moreover, whether the party invoking the MAC acted within its rights. MAC litigation often focuses on whether the events or changes at issue rise to the level of a MAC under the agreement’s specific MAC clause. Due to the uniqueness of each MAC clause and the circumstances surrounding the declaration of a MAC, courts analyze the entirety of the situation and weigh various factors. Consequently, and due to the courts’ fact-intensive analysis, an event causing a MAC in one instance may not result in a MAC in another. However, while varying results may occur, courts’ interpretations may generally be summarized into two broad categories.
First, courts will parse the language of the agreement’s MAC clause. Courts will look at the exact language chosen or omitted and whether the event at issue is one that the parties intended to be included under the MAC clause or excluded (by means of a carve-out) from the MAC clause.
Second, courts will analyze the facts and circumstances surrounding the alleged MAC. When analyzing the factual situation to determine whether a MAC has occurred, courts emphasize, among other factors, the magnitude of the change or effect and the durational significance of the change or effect. Courts also stress the heavy burden of proof and its importance in MAC cases, especially as they often look at the facts in MAC cases from a “seller-friendly” perspective.
MAC clauses in Delaware and Texas
Texas and Delaware courts have embraced a similar posture toward interpreting and enforcing such a special subset of contractual disputes. Although the case law in Texas is limited when it comes to MAC clauses, with respect to acquisition transactions courts in the two jurisdictions have emphasized a strong inclination toward respecting an agreement by parties that have ordered their affairs through a binding contract – and away from rewriting an agreement in which the court allocates risk after the fact.
Delaware
The traditional Delaware MAC interpretation has been reinforced in several cases, specifically, IBP, Inc. v. Tyson Foods, Inc., Frontier Oil Corp. v. Holly Corp. and Hexion Specialty Chemicals, Inc. v. Huntsman Corp. In these decisions, the Delaware Chancery Court narrowly construed MAC clauses that would have allowed a party to terminate the respective deals. In Frontier, the court specifically noted that the burden of proving a MAC fell upon the party asserting it. While in both Tyson and Hexion, the court stated that a totality analysis of the business, measured over a durationally significant timeframe, would be crucial in establishing if a MAC had occurred. The Delaware Chancery Court in these cases denied the right of a party terminate a deal based on the occurrence of a MAC.
Such a result changed with the Akorn, Inc. v. Fresenius Kabi AG decision in October. For the first time, the Delaware court upheld the buyer’s use of a MAC provision.
In Akorn, the parties argued over whether a MAC occurred that would entitle the buyer to terminate their April 24, 2017, merger agreement. For the court, a MAC happened in a manner that separated itself from the alleged MACs in the Delaware cases described above.
First, the court found that a general MAC had occurred. This MAC took the form of a significant and sustained downturn – over five straight quarters. It showed “no sign of abating.” It could only be credited to Akorn’s individual performance, and it showed no attribution toward broader industry performance.
Second, the court found that a regulatory MAC had occurred. In breach of the representations and warranties by Akorn on regulatory issues contained in the merger agreement, there was overwhelming evidence that Akorn had committed widespread regulatory violations and was currently under a whistleblower investigation. As a result of these regulatory issues, Akorn was unable to complete the bring-down condition to closing. Such an event permitted the buyer to refuse to close on accord that Akorn’s representations were not true at closing, except where the deviation from Akorn’s as-represented condition would not reasonably be expected to constitute a MAC.
While crucial in being the first result of its kind, the importance of the Akorn decision should not be interpreted to mean that Delaware is now open to finding MACs in every such dispute. Instead, Akorn should be read alongside the previously mentioned Delaware MAC decisions. Akorn did not change Delaware law, it reaffirmed it. Through the Akorn decision, the Chancery Court has endorsed the ideas that time, attention and properly written and construed MAC clauses will only be upheld when justified by the facts of the individualized case. Beyond that, MACs will not be allowed as tools for remorseful buyers trying to exit a transaction.
Texas
There is limited Texas case law that addresses the MAC issue directly. One leading Texas case is Borders v. KRLB Inc. In that case, the Texas appellate court refused to uphold the reading of a MAC clause for the buyer of two Texas radio stations after the seller’s stations experienced a large ratings decline and loss of half of its listening audience between the signing and closing dates.
The court held that a MAC was not triggered for two reasons. First, the specific MAC clause invoked said nothing about ratings loss. Second, even with the aforementioned ratings loss, the general operations of the stations would not change.
As such, it is important to note that the formulation of the MAC in this specific acquisition agreement at issue was very simplistic. The pertinent provision of the agreement referred to “material adverse changes” without providing a definition of a MAC. This approach is in stark contrast to the lengthy definitions of MAC – including exceptions and exclusions to the exceptions – customary in acquisition agreements today.
Perhaps even more noteworthy is the court’s emphasis on freedom of contract in the State of Texas. Consistent with the strong statements of Delaware courts in this regard, the Texas appellate court emphasized that its primary goal when construing the acquisition agreement was to give effect to the intent of the parties and that it cannot make a new contract for the parties.
Conclusion
Based on the Borders holding, as well as the contractarian policies expressed in that case and by other Texas courts since that ruling, it appears that in a number of ways Texas courts will treat MAC clauses similar to Delaware courts. For instance, one can ascertain that a party attempting to rely on a MAC to terminate an acquisition has the burden of proving that a MAC occurred. Further, the agreement’s actual contractual language will be a prominent guidepost of analysis for determining MAC qualification. Finally, and probably most importantly, a court’s analysis will be heavily influenced by the nature of the facts underlying the transaction as they fit within the language of the acquisition agreement.
For instance, a court will likely measure the magnitude and the durational significance of the adverse change against the language of the parties’ agreement. Consequently, a sudden change in the financial condition of a business, such as an abrupt drop-off in earnings, subscriptions or sales, will likely be reviewed from the longterm perspective of a reasonable acquiror, not a short-term speculator.
With that said, the Akorn decision does little to move the needle, in either Texas or Delaware, with regard to interpreting MAC clauses. As noted, Akorn simply provided a further building block for an already well-established Delaware MAC jurisprudence. A jurisprudence which, like in Texas, places emphasis on the terms agreed, the manner in which the MAC was construed, and the nature of the transaction as a whole. Only time and future decisions will tell if Texas decides to break from its current MAC interpretations.
Mike Blankenship is a partner in the Houston office of Locke Lord LLP and co-chair of the firm’s capital markets section where he focuses his practice on corporate finance and securities law, including securities offerings, special purpose acquisition companies (SPACs) offerings and transactions, private equity, mergers and acquisitions, and general corporate representation.
Whit Roberts, deputy managing partner of Locke Lord’s Dallas office, has extensive experience in a broad range of merger and acquisition, corporate finance and other corporate and joint venture transactions.