MAC Clauses in M&A transaction documentation and the COVID-19 Pandemic
Material Adverse Change Clauses, which have until now been rather rarely found in German law M&A transactions, will in view of the COVID-19 pandemic possibly again become the subject of intensive negotiations and more frequently become part of the transaction documentation. But do commonly used forms of MAC clauses apply in cases such as the COVID-19 pandemic? What must be taken into account in future negotiations and drafting?
Function and Content of the MAC Clause:
MAC clauses, which originate from the Anglo-American legal system and have always been widely used there, usually grant the purchaser the right to, in the event of a material adverse change (Material Adverse Change or "MAC" for short), either under certain conditions withdraw from the already signed but not yet closed purchase agreement or to assert corresponding guarantee claims. The applicability of the legal instrument of the disturbance of the contractual basis of frustration of contract (Störung der Geschäftsgrundlage) pursuant to section 313 of the German Civil Code (BGB), which is usually excluded in M&A agreements and according to which the purchaser would have primarily a claim to an adjustment of the contract, can be avoided by including a MAC clause into the underlying share or asset purchase agreement. In fact, this at least enables the purchaser to enforce a reduction of the purchase price by threatening to withdraw from the purchase agreement.
MAC clauses are to be distinguished from Material Adverse Event clauses (or "MAE clause" for short): While the MAC clause is based on the occurrence of a change between the signing and closing of the purchase agreement, MAE clauses generally also cover circumstances that already existed before the purchase agreement was signed but only become effectively apparent afterwards.
The legal forms of MAC clauses can be very different. They are often negative, thus, subsequent closing conditions, the occurrence of which depends on the non-existence of a MAC event up to the time of closing. This closing condition is usually accompanied – like also any other closing conditions – by a right to withdraw from/rescind the agreement, so that the purchaser can refrain from closing the transaction and withdraw from the purchase agreement if not all closing conditions are fulfilled by a certain date (so-called long stop date). Rather rarely, a MAC clause is designed as a guarantee given by the seller, which, in the event of a MAC event occurring between signing and closing, gives rise to a claim of the purchaser under the representations and warranties.
In jurisdictions where MAC clauses are used more frequently, they are usually formulated in a very abstract manner, as it is usually not possible to assess at the signing date which circumstances could have such a serious influence that they would significantly affect the economic situation of the target company.
If a MAC clause contains a specification, the definition of the MAC event strongly depends on the concrete form of the transaction and the industry of the target company and can therefore vary considerably. In principle, such circumstances that result in a material adverse change in the financial position, sales or earnings of the target company are regularly recorded. It is often the subject of intensive negotiations whether a change must have actually occurred by the time of closing or - as is usual in the case of very purchaser-friendly wordings - the circumstances prevailing up to that time must merely indicate that such a change is likely to occur.
For the purpose of concretization, MAC clauses often contain a catalogue of examples of MAC events which shall be either explicitly covered or excluded from the scope of the clause. MAC events are usually categorized as follows: Events related to the sphere of the target company, thus to its business operations, are referred to as Business MAC or Company MAC. These events can be, for example, the loss of a license necessary for business operations of the target company or the termination of important contracts. Events that go beyond internal business processes and relate to the market environment of the target company or general developments are referred to as Market MAC. These include, for example, environmental and natural disasters, military conflicts, terrorist attacks, economic downturns, stock market and financial crises or other general events that could have a serious negative impact on the economy. In the case of externally financed transactions, events relating to the financial feasibility of the transaction (so-called Finance MAC) are sometimes also included in the MAC clause. A further subgroup are Compliance MAC clauses, which are based on a (grave/serious) breach of compliance regulations by the target company.
Furthermore, the specification of the materiality of the negative change is highly important for all contracting parties. For this purpose, certain materiality thresholds are usually defined. In this respect, it is important to define a meaningful point of reference. Very general wordings, according to which, for example, the financial or income situation of the target company shall be taken as a basis, often lead to uncertainty in practice, as it remains unclear on the basis of what specific financial key figures, such as EBITDA, profit, enterprise value or equity value, the determination shall be made. It could be agreed, for example, that a negative change is only deemed to be material within the meaning of the MAC clause if the sales or the reduction in EBITDA of the target company decreases by a numerically specified percentage. In addition to financial thresholds, temporal thresholds can also be agreed, such as the minimum duration of a strike or interruption of the supply chain as well as a minimum duration of the deterioration of the agreed key performance figures.
If the MAC clause contains an explicit list of specific/concrete examples, there is a risk for the purchaser that circumstances not included in the catalogue or not comparable with the examples mentioned will not be taken into account in the course of a (judicial) dispute. The inclusion of an explicit clarification that the catalogue shall not be exhaustive is therefore quite advantageous for the purchaser, but often difficult to push through within the framework of negotiations.
In the event that the purchase price is financed externally, the underlying financing agreements often also contain a MAC clause. If this clause differs in content from the MAC clause contained in the purchase agreement, there is a risk that the financing bank will withdraw from the financing agreement while the purchaser remains bound by the purchase agreement.
Interests and impact of the COVID-19 pandemic:
As a rule, the seller is not interested to include a MAC clause, as it leads to a significant shifting of risk to his disadvantage inasmuch as occurrences between signing and closing of the purchase agreement are concerned. If the seller agrees to the inclusion of a MAC clause, he will be interested to keep the scope of the clause as narrow as possible and limit it to business-related circumstances, i.e. business MACs.
However, it is in the purchaser's interest to include a clause as comprehensive as possible and not limited to company-specific circumstances but also covering industry-related and general economic processes or developments.
Due to the very seller-friendly M&A market in recent years, it was generally very difficult for the purchaser to negotiate the inclusion of a MAC clause in the purchase agreement. In the future, purchasers may want to be protected by additional closing conditions, rights of rescission and/or corresponding guarantees in the form of extensive MAC clauses in order to cope with the expected economic decrease caused by the COVID-19 pandemic and the resulting uncertainties when acquiring a company. In view of the currently hardly foreseeable extent of economic consequences, it will be difficult for the seller to completely reject a purchaser's increased need for security as unjustified or unfounded. The COVID-19 pandemic could therefore lead to an increased inclusion of MAC clauses in SPA’s and APA’s.
Does the COVID-19 pandemic trigger existing MAC clauses?
With regard to currently ongoing/pending transactions, it should be examined on the basis of the present contractual situation whether the purchaser can withdraw from the signed but not yet closed agreement if the economic situation of the target company significantly deteriorates (or has deteriorated) due to the COVID-19 pandemic.
Whether the COVID-19 pandemic can cause a right of withdrawal by the purchaser under a MAC clause depends on its specific wording. Often, commonplace MAC clauses do not explicitly cover the case of an almost worldwide or global shutdown due to a mass spread of a viral disease. In many cases, changes in the general economic conditions or the industry of the target company are unlikely to be covered by the definition of the MAC. In fact, pandemics are often even explicitly excluded from the possible reasons for a withdrawal right in conventional MAC clauses.
Even if the relevant MAC clause does not explicitly exclude pandemic cases, it is questionable whether the COVID-19 pandemic is covered by the scope of the MAC clause. In the case of MAC clauses as commonly used, it could be discussed whether the COVID-19 pandemic could be considered as a natural catastrophe, similar to an earthquake or hurricane. However, this seems highly questionable, as pandemics, although of natural origin, are unlikely to be considered as natural events.
Future design of MAC clauses from the purchaser's or seller's point of view against the background of the COVID-19 pandemic and similar circumstances:
In respect of drafting future share or asset purchase agreements, it should be considered whether and in what form potential effects of COVID-19 or similar pandemics should be regulated and what types of clauses can realistically be asked for in the contractual negotiations - and enforced at a later stage.
From the purchaser's point of view, the inclusion of a MAC clause and the extension of the MAC event catalogue by, for example
- the mass spread of a pathogen,
- a strong downturn of the stock market,
- a significant interruption of the supply chain,
- a considerable decline in orders and
- a deterioration in the business prospects of the target company
would seem advisable.
A high probability of occurrence should be sufficient for the respective MAC event to be considered to be triggered. Otherwise, the purchaser takes the risk of not being able to withdraw from the purchase agreement in time, as the target company's business figures are not yet affected even at the time of the closing of the purchase agreement, although the downward trend in the respective market is already foreseeable.
If the purchase price is financed externally, it should also be ensured - as with all closing conditions - that any MAC clause contained in the financing agreement is identical to the MAC clause in the purchase agreement.
From the seller's point of view, if an inclusion of a MAC clause in the purchase agreement cannot be avoided - against the background of the Parties bargaining powers or for other reasons, the MAC clause should be limited to internal circumstances of the target company. Adverse changes in the general economic or respective market situation or the mere probability of events occurring should be explicitly excluded from the scope of the clause.
If a seller is forced to accept a Market MAC clause or even more comprehensive wording due to the specific negotiation situation, the inclusion of concrete materiality thresholds should in any event be demanded, i.e. thresholds pursuant to which a right of withdrawal for the purchaser only materializes if the circumstance triggering the MAC clause or the corresponding event leads to a concretely identifiable deterioration of the financial figures with a material impact (e.g. reduction of EBITDA by value X) at the target company, which will be not only a short term event (e.g. > 6 months), according to the qualified opinion of an expert.
In order to reduce the purchaser's motivation to withdraw from the purchase agreement in the event of a MAC, the seller could insist on a break-up fee, which would oblige the purchaser to pay a contractually agreed compensation amount in the event of a MAC-induced withdrawal.
If the parties decide to include a MAC clause in the purchase agreement in the form of a negative closing condition and/or a right of withdrawal, they should be aware that this may lead to considerable legal uncertainty and significant practical problems in the event of a dispute. An (arbitration) court dispute over whether or not the conditions of the MAC clause have been met can take several years, during which it remains completely unclear how the target company is managed.