Covid-19 and Material Adverse Change Clauses

General

The global outbreak of the Corona virus (Covid-19) is heavily affecting both the current state of many businesses and their forward-looking prospects. The large degree of anxiety and uncertainty which the whole world is currently facing will, inevitably, also have implications on the m&a market.

In particular, deals involving regulatory aspects, such as merger control clearance, often entail that the signing and closing of the deal are separated from each other. Naturally, a longer interim period between signing and closing increases the level of risk which a buyer may face before closing the deal. In share purchase agreements, material adverse change clauses (MAC clauses), occasionally also defined as material adverse effect clauses (MAE clauses), usually aim to protect the buyer from circumstances having a negative impact on the target company, which may arise in the interim period between signing and closing. Given the Covid-19 virus crisis currently at hand, MAC clauses in share purchase agreements have, once again, been put under the spotlight.

The various functions of MAC clauses

MAC clauses can serve various functions in the share purchase agreement. Firstly, the MAC clause may function as a condition precedent enabling the buyer to walk away from the deal should a material adverse change occur between signing and closing. Similarly, the MAC clause may serve more as a bring-down representation and warranty at closing stating explicitly that no material adverse change has occurred on or prior to closing. Occasionally, MAC clauses are also used to qualify representations and warranties given by the seller, i.e. only those representation and warranty breaches constituting a material adverse change shall be subject to the remedies which have been agreed upon under the share purchase agreement.

Historically, the threshold for applying MAC clauses as conditions precedent has been very high. Most of the existing publicly available case law in the subject matter derives from Delaware, United States, where the discussion around the applicability of MAC clauses has focused a lot on the interpretation of “material”. In Finland, there is very little case law available on the interpretation of MAC clauses, since most m&a related disputes are settled by arbitration. However,  a MAC clause functioning as a condition precedent in a share purchase agreement governed by Finnish law, which has been formulated only in broad terms without the inclusion of specific examples of triggering events, is less likely to be interpreted in favour of the buyer than a detailed MAC clause. Therefore, similar to force majeure clauses, from a buyer’s perspective, the MAC clause should be defined in close detail, listing various triggering events and quantified thresholds (e.g. a specific decline in EBITDA, other balance sheet impact or loss of a material agreement of the target company) and, ideally, ending with a sweeper (without limitation/and any similar circumstances). However, given the rather seller-friendly m&a market which has prevailed in the past years, the use of MAC clauses in share purchase agreements has been restrictive. Consequently, in deals where a MAC clause has been included in the share purchase agreement, the wording of the clause has often included several carve-outs with respect to the underlying events that may cause a material adverse change, such as changes in the general economic or political environment, general changes in commodity or market prices, national emergency or acts of terrorism. Effectively, a long list of general carve-outs will set a high threshold for the applicability of the MAC clause.

Outlook

Depending on how long-standing the Covid-19 crisis and the effects thereof will be, MAC clauses in share purchase agreements may become subject to closer negotiation between parties in the near future. At the same time, the Covid-19 crisis may cause a shift to a more buyer-friendly m&a landscape which, potentially, will strengthen buyers’ position when negotiating the specific wording of MAC clauses or improve the buyer’s possibility to receive protection against adverse changes. From a buyer’s perspective, the wording of the MAC clause should be as precise as possible, setting out, where possible, exact thresholds and concrete examples of, inter alia, the underlying events that may trigger a material adverse change under the share purchase agreement, such as pandemic or natural disaster, without including too many carve-outs of general nature that will, ultimately, water down the applicability of the MAC clause. However, even if the MAC clause would not, as such, become applicable in a particular case, the inclusion of a MAC clause in a share purchase agreement may also have other indirect implications for the parties. For instance, in situations where the applicability of a MAC clause remains unclear under the circumstances at hand, the inclusion of a MAC clause could, eventually, lead to e.g. a renegotiation of the pricing terms, unless the pricing mechanism and other relevant terms and conditions under the share purchase agreement already provide sufficient comfort to this extent.

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