As the COVID-19 cases rise has been ubiquitous, the pandemic has proven to be an unprecedented public health emergency of our time. With nations enforcing social distancing, lockdown, and travel restrictions, the global economy has witnessed a drastic downswing. In India, RBI has warned of a growth slowdown, and the capital markets have slumped. Private equity investments within the country have to be in desperate straits, and therefore the pandemic has caused investors to reassess new and existing investments.
Given the likely economic aftermath of COVID-19, we need to understand the basics of MAE clause in transactions. In merger and acquisition agreements, a Material Adverse Change (MAC) provision, also known as a “Material Adverse Effect” (MAE), allocates financial and other risks relating to the business and the acquisition transaction between the buyer and the seller. As a general rule, a MAE provision captures unforeseen events or consequences that have a long-term, dramatic and adverse effect on the value of the target. As such, MAC/MAE clauses may allow a party to postpone or terminate the transaction if there is a change in the circumstances that significantly lessens the value of the target company or business.
Generally, in an M&A transaction, the time between the signing of the agreement and closure of the transaction is very crucial and remains under the cloud of vagueness until they are closed. It is when a MAE clause comes to operation, it confers the parties to a contract with a right to terminate the contract upon the occurrence of any event which affects materially on the viability of the transaction. However, to agree upon the materiality of an event by both parties of a contract is not an easy task. On one hand, the seller in an acquisition transaction would prefer to narrow the scope of the definition of materiality, on the other hand, the buyer would prefer to keep it open and as broad as may be possible so that it is easier for them to escape the responsibility of the transaction, and that is why often such transaction agreements shy away from defining what is material to the transaction. Correlatively, the parties heavily negotiate MAE provisions, their limitations, and exclusions. There is typically no specific language defining what exactly constitutes a material adverse change.
Ensuing, the courts use a fact-based analysis to declare whether a material adverse change has been triggered. The party arguing for the application of the material adverse change provision must show that the adverse change substantially threatens the overall earning potential of the target company in a durational-significant manner or in other words, over an extended period of time, usually years. However, most of the MAC and MAE provisions commonly exclude the effects of global market conditions, acts of God, pandemics, and health emergencies from the definition of MAE, unless there has been a disproportionate effect on the company.
Typically, a MAE provision kicks in when an unknown event can alter the status of a target’s business, its continued existence, or the enforceability of the documents from the time the acquirer has agreed to acquire such business to the time the acquirer actually acquires the business. The impact of the present uncertainties may also have a telling impact on deal-making. M&A transactions that are in the pre-signing or the pre-closing stages will, undoubtedly, be subject to the COVID-19 endurance test. The determination of whether COVID-19 would qualify as a trigger under an MAE/MAC provision requires a case-by-case determination, and will, inter alia, depend on the language of a contract along with the law governing such contract. Considering the current ambiguity and the differing risks in various deals and contracts, this piece seeks to address points to consider from a contracting perspective in M&A deals.
Negotiating an MAE Clause in the light of COVID–19
- With respect to M&A transactions that are currently under negotiation, parties should consider specifically addressing how the COVID-19 pandemic should be treated in the agreement. It will help in providing clarity regarding the risk that could impact the transaction.
- Sellers are likely to suggest that the negative effects of the COVID-19 pandemic may not affect the transaction. Buyers may not be willing to take risks arising from the COVID-19 pandemic.
- Given the courts’ approach to strictly interpret MAE clauses, buyers should not rely on general terms and they should negotiate a specific closing condition, if commercially required, regarding the spread of the COVID-19 outbreak. Sellers are unlikely to take deal execution risks relating to COVID-19 and are likely to push back on the buyers seeking specific closing conditions or pause the transaction to allow the COVID-19 pandemic and its consequences to play out. As in any other case of a known risk, parties will need to find a mutually agreeable position and document the same clearly.
Ultimately, in light of the coronavirus pandemic, it is important to look closely at existing agreements with a particular focus on the provisions mentioned above and taking into account important contractual principles. This will help to determine the contours of the business relationships and the respective rights and obligations of the parties or their possible limitations.
This article has been co-authored by Nishant Tiwari 3rd year B.A.LL.B. Hons. (National University of Study and Research in Law, Ranchi) and Suyash Shrivastava 3rd year B.A.LL.B. Hons. (Hidayatullah National Law University, Raipur).
