It has become something of a truism for English M&A lawyers to say that material adverse change (MAC) clauses are rarely triggered in practice. A recent English judgment in Travelport Ltd v Wex Inc  EWHC 2670 (Comm) will be of interest to parties to M&A transactions as it highlights the English courts’ approach to one of the key aspects of such claims.
In a trial on preliminary issues, the High Court considered the construction of a MAC clause in a share purchase agreement for the entire share capital of two related B2B payments companies. The agreement was signed in January 2020 and completion of the transaction was subject to customary conditions precedent, including the absence of a material adverse change in respect of the target companies and their respective groups. The agreed purchase price exceeded U.S. $1 billion (likely one of the reasons why this dispute reached the trial stage).
MAC clauses are typically encountered in lending documents, but also find their way into acquisition, joint venture and technology licensing agreements, to name a few. It is one of the tools used by parties to allocate risks that are outside their control or risks that they can’t anticipate at the time of signing. A buyer may seek to include a MAC clause in an acquisition agreement to protect itself against an event or occurrence that has, or is likely to have, material adverse effect on the financial position or business of the target between signing and completion. Consequently, the buyer often insists on the right to walk away from the deal if the MAC clause is triggered before completion and can use it to force the seller to renegotiate the purchase price. Thus, a seller will want the MAC to be tightly defined to a limited set of events or circumstances. If there is a dispute whether a material adverse event has occurred, the parties may need to settle their differences in court.
It is worth noting that the MAC clause used in the agreement in this case, which was governed by English law, had the structure that is more typical for U.S.-style agreements (i.e., a list of the trigger events subject to generic carve-outs, which are in turn subject to certain exceptions to cater to disproportionally affected targets). In practice, there is a wider variety of drafting such clauses in English law-governed agreements, but the general principles underlying them are the same. As is always the case with legal arguments involving questions of contractual interpretation, a lot will depend on the exact wording of the relevant provision. In this case, Mrs Justice Cockerill confirmed that no special rules of interpretation would apply when considering MAC clauses, such as construing them narrowly or placing a higher than usual evidentiary burden on the party invoking them.
The definition of MAC used in the agreement in question contained a carve-out relating to “conditions resulting from … pandemics” and a carve-out exception providing that, where an adverse event otherwise fell within the carve-out, the buyer could invoke the exception (and thus rely on the MAC condition precedent) if the event had “a disproportionate effect on [the target groups], taken as a whole, as compared to other participants in the industries in which [they] operate.”
The central point of contention revolved around the meaning of the word “industries” when used to define the intended comparator group in the carve-out exception. The sellers contended that the correct interpretation of the term was the “travel payments industry,” while the buyer argued that the relevant comparator should be the participants in the “business-to-business payments industry.” The travel industry has been particularly adversely affected by the pandemic, and that had a negative effect on the payment services providers focusing on that segment. The narrower interpretation would have favoured the sellers, as it would have been easier for them to show that the target companies were not disproportionately adversely affected when compared to a small selection of their direct competitors. Conversely, if the buyer’s view were to be preferred, the buyer would have found it easier to prove that when compared to companies in the wider B2B payments industry, the target companies (as well as their direct competitors) were disproportionately affected, and that the MAC clause was therefore engaged.
Since the parties appeared to have opted not to clearly define the comparator group in the disproportionality exception, and did not use this ambiguity to restart the price negotiation process, it was left to the judge to determine an objective intent of the parties at the time of the entry into the agreement, which may have never been subjectively shared by the parties.
Because of a dearth of relevant English authorities on the construction and application of MAC clauses in the context of company acquisitions, the judge’s attention was drawn to Delaware caselaw and available U.S. academic commentary. She concluded that there was no clear authority or rationale to favour the sellers’ view that the purpose of MAC clauses is to allocate only target-specific risks to the sellers (i.e., risks to the business that eventuate because of the way the target business has been conducted, including in response to events that affect the industry in which the company operates generally). On the proper analysis, having considered the factual matrix and the agreement as a whole, the MAC clause in question allocated how much of the systemic risk each party was to bear in the period prior to closing, and the disproportionality exception required a comparison to be made between the target companies (and their market segment) against the wider B2B payments industry.
This case highlights that careful consideration needs to be given to the drafting of MAC clauses, in particular when defining the relevant comparator group in any exceptions. The judge noted that the parties could have but did not specify what industries (or markets, sectors or competitors) they meant, and that future drafters may want to be more prescriptive. Generally, it would be in both parties’ interest to define what is meant by material adverse effect in the interests of commercial certainty and to avoid a trip to the courts. The parties should also consider the practical aspects of using the relevant comparator group in the time constraints imposed by the deal schedule, as they may need to determine the effect of the alleged MAC event on the target in what often is quite a limited window between singing and closing.
Because this was a hearing on preliminary issues, it remains to be seen if the sellers are allowed appeal on those issues and if the parties eventually proceed to the substantive hearing on whether there was a material adverse event or if the buyer should be required to complete the purchase.
In terms of drafting, it is worth noting the developing practice of expressly excluding COVID-19 from the MAC definition on the basis that, at this point, it is a risk that the purchaser should be able to evaluate and factor its effect into the price, including sharing the risks through price adjustments or earn outs. Even if not excluded by clear wording, the party wishing to rely on the MAC clause may find it an uphill battle. As a matter of English law, a party cannot rely on a MAC clause on the basis of circumstances of which it was aware of entering into the agreement (i.e., there must be some change in the conditions / circumstances), although this does not preclude attempts to claim that the worsening of the pandemic may have caused the alleged material adverse effect.
Similarly, contracting parties should consider whether to include or exclude the COVID-19 pandemic as a force majeure event. This would depend on the nature of the contract and the potential effects of the continued lockdowns and other governmental actions on either party’s ability to perform its contractual obligations or how they could impact the buyers’ ability to conduct an effective due diligence.
It remains to be seen to what extent buyers would be able to rely on COVID-19 as an excuse to pull out of deals by relying on available contractual protections, such as force majeure and MAC provisions, as well as on common law relief related the doctrine of frustration of contract. MAC clauses specifically may receive increased attention by the judges as the fallout from the current COVID-19-related crisis continues to impact deals signed but not completed prior to its onset.