Hours, if not days or weeks are spent negotiating the material adverse change (MAC) clause in acquisition or financing agreements. The debate around these clauses centres on how much actual value and protection they afford to their intended beneficiaries.
A MAC clause is a clause in an agreement that allows a purchaser to walk away from an agreement with no or little legal consequences or to suspend performance of the agreement if certain prescribed events, developments, circumstances or changes occur in the target or borrower company within defined time periods, including between the period of signing and closing. These events must typically have an adverse effect on the business (or ability to carry on business), assets, liabilities or operations of the target or borrower company and its subsidiaries.
The MAC clause will define what a material adverse change is, provide for carve-outs designed to benefit the seller and exceptions to those carve-outs for the benefit of the purchaser. The cases from the US dealing with MAC clauses have highlighted the reluctance of those courts to find that a MAC has indeed occurred thus releasing the purchaser from its obligations in the agreement in question.
Interestingly enough, despite the hours and fervour spent by lawyers and financiers debating these clauses, there is not a single reported case dealing specifically with MAC clauses in South Africa.
The uncertainty of these clauses largely lies in the fact that they are untested in the courts and yet they often form the only viable exit for the disgruntled purchaser. Critics have suggested that these clauses are often used by purchasers suddenly left suffering the after effects of buyer’s remorse. In the US case of Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 2008 WL 4457544 (Del. Ch. 2008), the court emphasised the point that MAC clauses are not intended to afford a solution to a purchaser suffering from buyer’s remorse or anything of the like.
The parties involved in the drafting of the material adverse change clause should ensure if possible, that monetary thresholds are prescribed in the clause, specific wording is used to describe the changes envisaged and ensure that were the clause to be litigated upon, it would be found to be objective and reasonable. The party alleging that a MAC has occurred will also be saddled with the onus of proof. For this reason, MAC clauses should be viewed as an exit of last resort ie after representations, warranties and suspensive conditions can no longer be of aid to the purchaser.
There are numerous cases in the US that have dealt with the question of what “material” means in this context and what it entails for the purposes of asserting that a MAC has occurred. Of particular interest and relevance are the cases of In re IBP, Inc. Shareholders Litigation, 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil v. Holly, No. 20502, 2005 WL 1039027 (Del. Ch. April 29, 2005,) in which the second judgment echoed that of the first in that “short-term hiccups” in the financial and economic performance of the target company that are not expected to continue for prolonged periods of time generally do not give rise to the right to assert that a MAC has occurred. The MAC clause can therefore, these courts have held, not act as insurance for the purchaser against downturns in the market. The trend in the US is for the courts to find in favour of upholding the agreement instead of accepting the invocation of the MAC by the purchaser.
We hold the view that were a MAC clause to find its way to a South African court, the court would fundamentally concern itself with the wording of the clause and the intentions of the parties at the time of the drafting of the clause as opposed to reading into the intentions of the parties after the fact. The court is also very likely to highlight the fact that in our legal system, the signatory to an agreement is deemed to be fully aware of the contents and the implications of the agreement and therefore that the agreement is fully binding between the contracting parties. In reaching its decision, the court is likely to consider the specific wording of the clause, how broadly or narrowly it is drafted, the overriding intention of the parties and the extent to which the facts ascribe to the meaning given.
The UK Panel on Takeovers and Mergers (UK Panel), in its statement to the offer made by Group Plc for Tempus Group Plc, articulated the difficulty that the UK Panel has with allowing the acquirer to invoke the MAC clause because, on the announcement of the takeover, the share price is affected with direct and almost always instant consequences for the target company.
Although not definitive, the test set by the UK Panel for the inclusion and general ability by the purchaser in takeover transactions to invoke the MAC clause is that the MAC clause itself be specific, objective and material. The UK Panel in the above matter held that the test for materiality must be that the material change that the purchaser seeks to assert, must strike at the heart of the purpose of the transaction thus justifying frustration of the legal contract. This means that the adverse change in the target company must be of an allegation of considerable significance, ie going against the basis on which the purchaser entered into the agreement to begin with.
Although no reported cases exist on MAC clauses in South Africa, the US courts are generally not in favour of terminating an agreement based on the assertion of the purchaser that a MAC has arisen. However, the value of the MAC clause should not be lost sight of. At the very least, the MAC clause provides the purchaser with the flexibility to start the conversation with the seller around the renegotiation of the agreement where a perceived material change of circumstances does arise.
Robert Driman is a director and Tinyiko Ribisi is an associate at Norton Rose SA.
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