COVID-19 – a material change?

Several Australian companies have been pulling out of, or postponing, takeover deals due to the devastating economic impact of the coronavirus (COVID-19).

What is their mechanism? 

A material adverse change clause ("MAC").

Lawyers and bankers alike predict that there is going to be a surge in businesses seeking to invoke MAC clauses in all jurisdictions, due to an inability of purchasers to complete a deal at the price originally negotiated.

So what is a MAC?

In the context of M&A and takeovers, it is a clause which aims to give the buyer the right to walk away from a transaction, if events occur that are materially detrimental to the target company.

MACs are also found in facility agreements, seeking to protect the lender if circumstances arise which will seriously compromise the borrower's ability to repay a loan.

Language is key

MACs are, in theory, a catch-all concept. They seek to provide the buyer with maximum protection to walk away from, or renegotiate, a deal in the face of material changes. However, it should be noted that the sheer presence of a MAC will not automatically cover a purchaser. Whether a purchaser can invoke a MAC clause will entirely depend on the specific drafting of the relevant clause (and its interaction with other key clauses and 'boilerplate' in the contract).

So how will these work in the UK?

In terms of public takeovers here in the UK, the takeover code offers some guidance. Rule 13.5(a) and accompanying executive statements confirm that the appropriate test for when a business can validly invoke a MAC is "whether the relevant circumstances upon which the offeror is seeking to rely are of material significance to it in the context of the offer". The offeror will need to demonstrate that exceptional circumstances have arisen that affect the target and would not have been reasonably foreseeable by the offeror at the time that it announced its offer. Therefore, situations will need to be considered on a case-by-case basis, and firms should take advice before seeking to rely on a MAC clause.

As a general rule of thumb, a buyer will have much more certainty from a MAC which is expressly triggered on specific events with specific consequences, than from a more general MAC clause, such as a specific drop in revenue over a specified period of time.

COVID-19 and the outbreak itself are not going to qualify as material changes. However, the detrimental financial impact that it can have on a firm's business could, theoretically, constitute a situation where a MAC can be invoked.

In the context of private M&A, whether a material adverse change has occurred is generally for factual determination. The court will use usual rules of contractual interpretation.

There is limited UK case law to guide us (drafting is varied and each case is fact specific), but one key takeaway is that the material change cannot be a temporary one – there must be a degree of permanence to it. If litigated, there will be a heavy evidential burden on the party seeking to invoke the MAC.

Given the likely long-term economic effects that the pandemic is going to have, and the time it is going to take to emerge from this situation, firms should be reviewing their MAC clauses and taking advice on next steps. Whilst a buyer may not have the appetite to approach the courts for a ruling (noting time and costs especially in the current environment) a well drafted MAC may at the very least give the buyer a good position to start from for re-negotiating terms.

Please get in touch with Gillian White or James Wilson if you'd like to discuss.