- Some buyers have tried to walk away from deals that haven’t yet closed, citing, among other issues, a contract clause called a material adverse change.
- Even though it’s difficult to trigger, the clause is coming into play during the pandemic.
- Recent deals that have invoked the MAC clause, often alongside other issues, include Sycamore Partners’ purchase of a majority stake in Victoria’s Secret, which fell apart last month.
- A deal between Carlyle and a sovereign wealth fund to buy a stake in American Express Global Business Travel is currently winding through Delaware Chancery Court.
- One top M&A attorney cautioned that when buyers and sellers spend too much time negotiating the clause, deals can fall apart.
- Click here for more BI Prime stories.
In the aftermath of the financial crisis, buyers’ remorse hit hard, leading to lawsuits about when, if at all, companies could back out of deals.
Courts, keeping with earlier cases, ruled against buyers who wanted to walk away from transactions because their acquisitions’ financials worsened after a deal was agreed.
For example, after an Apollo-backed chemical company agreed to acquire Huntsman Corporation in 2007 and before the deal closed, Huntsman’s earnings worsened.
Apollo and its portfolio company tried to invoke a material adverse change clause, which gives the buyer the right to end a deal if its acquisition’s business experiences a significant change, but the Delaware Court of Chancery found that Huntsman’s financials didn’t represent a significant enough change, among other issues.
Now, similar discussions are cropping up again for buyers who signed deals before the pandemic hit and who now look to get out of their purchases as revenue dries up and uncertainty sets in.
At the heart of these arguments is a common contract clause known as material adverse change or material adverse effect. Companies often stipulate what doesn’t count as an MAC, including, for a number of deals in recent months, a pandemic.
But even before deals are agreed, negotiations over this clause can derail things, said one top lawyer. And after the deals are signed, buyers’ threat of expensive, long litigation over the clauses can lead buyers and sellers to rethink their original agreement and potentially prompt renegotiation.
Recent deals that have invoked the MAC clause, often alongside other issues, include Sycamore Partners’ purchase of a majority stake in Victoria’s Secret, which fell apart last month, and a deal between Carlyle and a sovereign wealth fund to buy a stake in American Express Global Business Travel, which is currently winding through Delaware Chancery Court.
LVMH Moët Hennessy Louis Vuitton had discussed ways to lower the price it was paying for jeweler Tiffany & Co in a $16 billion deal announced in November that hasn’t yet closed, according to media reports earlier this month.
The coronavirus pandemic has slammed the global luxury goods market, and Tiffany on Tuesday reported that sales plunged for its fiscal first quarter. But the company said it had received some antitrust clearances needed to proceed with the deal, and CEO Alessandro Bogliolo said in the earnings release that “Tiffany’s best days remain ahead of us and I am excited we will be taking that journey with LVMH by our side.”
Kevin Lehpamer, an M&A-focused partner at Clifford Chance, told Business Insider that conversations around MACs are becoming more focused because of the pandemic.
“Clients want to understand if they could use that as a lever to get out of a deal. While you may have had that conversation on certain transactions before, now you’ll have it on every transaction,” he said.
This all comes as the dollar volume of announced M&A deals has plunged in recent months.
Goldman Sachs research analysts wrote in a June 3 report that the year-to-date total of announced deal activity had tumbled 46% versus 2019, and that they expected full-year volumes to end up some 40% lower than the previous year.
Short-term hiccups don’t count
Buyers who try to invoke a MAC condition in lawsuits to get out of a deal face an uphill battle, making some of the current debates around the clause “much ado about nothing,” said Ben Sibbett, an M&A-focused partner at Clifford Chance. Courts have only ruled that a MAC occurred in a single case.
“When you dig into what a material adverse change is, and what it isn’t, you quickly realize that it’s not as simple as people think,” Sibbett said. “When you look at the case law around it, that law and related history make clear that buyers face an exceptionally high burden to demonstrate that a MAC has actually occurred.”
Any lawsuit citing a MAC because of the pandemic will likely be on shaky ground, because the adverse change must be significant to the company’s long-term earnings power; last for years, not months; and affect the company more than its peers. In recent months, wide swaths of industries, from retail to entertainment to travel, have been hit by stay-at-home orders and uncertainty stemming from the pandemic.
“The case law says that short-term hiccups in earnings don’t count,” Sibbett said.
Tom Harris, a Dallas-based attorney who chairs Haynes and Boone’s M&A practice, said that when he advises buyers, he asks them to think through what would cause cold feet. Often, arranging and closing the deal’s financing is a top priority, which can be dealt with outside of the MAC clause.
“If the market falls apart and nobody’s lending money … then the buyer doesn’t have to close, but it’s not based on a general MAC provision,” Harris said.
Constructive ambiguity
David Katz, a partner at Wachtell, Lipton, Rosen & Katz, said in a late May panel hosted online by Reuters that more parties will try to negotiate the MAC.
Buyers and sellers took similar steps in 2009, he said, when some deals fell apart because the parties couldn’t agree on specific thresholds for what constituted a material change.
“When parties are forced to say ‘$75 million’ or ‘this decline in revenue’ … and they try to negotiate those, that’s where the deals often fall apart because people aren’t willing to be that finite, and they’re also concerned about whether the deal will actually close,” Katz said.
The ambiguity of an MAC can be “constructive,” he said.
“The buyers think of it one way, the seller may think of it a different way, but because you’re not trying to specifically define it and narrow it to a very small band, the parties each have their own perspective and they can enter into the deal on that basis.”
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