COVID-19: Material Adverse Change in a Canadian M&A ContextThe unprecedented suddenness and uncertainty of the impact brought on by COVID-19 has many businesses re-evaluating their business strategies, business continuity plans and transaction proposals. In particular, businesses will need to review pending acquisition agreements and consider "material adverse change" or "material adverse effect" (MAC) clauses. These clauses typically allow a party to walk away from a transaction where a material adverse change has occurred between signing and closing. Definition and ApplicationMAC clauses are often considered "a term of art" given the highly contextual interpretation used to describe a potential event that affects a target business. In the M&A context, a typical MAC clause may be defined as any change, effect, fact, circumstance, occurrence or event that, individually or in the aggregate, is materially adverse to the business, operations, assets, properties or condition (financial or otherwise) of the target business, or that could delay or impair the ability of a party to consummate the transaction. MAC clauses are commonly relied upon in two ways:
Successfully invoking the applicable MAC clause as a condition to closing has been generally accepted to require that a high threshold be met. Role of Carve-outsA MAC clause is generally qualified by exceptions and exclusions that limit the application of the clause and its negotiation results in an allocation of risks between the purchaser and seller. Typically, a purchaser is expected to accept broader industry-wide and exogenous risks associated with the acquisition, while a seller accepts responsibility for business-specific and endogenous risks unique to the target business and unknown to the purchaser. Carve-outs from a MAC clause, which benefit the seller, customarily include: (i) changes in applicable laws, (ii) accepted industry-wide fluctuations or risks affecting the industry, (iii) changes in general economic or political conditions, and (iv) acts of war, terrorism, natural disasters and the like. Whether pandemics fall within the ambit of a MAC clause or are excluded by a carve-out will depend on the specific words used and surrounding circumstances. To reduce uncertainty going forward, parties may consider explicitly dealing with pandemics in the definition of a MAC clause. TakeawaysAs the COVID-19 pandemic is constantly evolving, its true impact remains to be seen. Whether a MAC clause can be invoked during, or as a result of, this pandemic necessarily involves contextual considerations and will depend on how Canadian courts approach MAC clauses given the idiosyncrasies of a pandemic-type event. Any purchaser contemplating invoking a MAC clause to avoid an obligation to close a transaction will need to consider the following three critical factors before proceeding:
Convincing evidence is required before a purchaser can defensibly walk away from a deal based on a MAC event. Properly assessing the likelihood of succeeding in a particular case will entail a thorough review of the specific MAC clause in the context of all of the provisions of the contract and relevant circumstances surrounding the contract negotiation, together with a factual analysis of whether a material adverse change fundamentally and disproportionately altered the financial condition of the target business relative to its industry peers. While the COVID-19 pandemic likely qualifies as an unforeseen event that defies any business norm or cycle, additional time may be required until its true impact can be properly quantified and analyzed. Qualifications to Representations and WarrantiesA MAC clause may also be used as a qualification to certain representations and warranties made by the seller. The threshold of a MAC clause is very high and places a heavy burden on the purchaser to prove that a seller has breached a representation or warranty. For example, rather than prove that an adverse change occurred, a purchaser will have to prove that a material adverse change occurred or would reasonably be expected to result in a material adverse change. Depending on its usage and context, a MAC qualifier may negate the substance of a representation or warranty. Case LawThe case law in Canada examining the treatment of MAC clauses is sparse, with no well-established analysis discerning the treatment of the often intentionally broad provision. There are recent decisions of the Delaware courts which may be considered by, but are not binding on, Canadian courts. The 2018 decision in Akorn Inc. v Fresenius Kabi AG (Akorn) has been oft-cited as a landmark case on this clause, as it became the first Delaware decision to hold that the purchaser was contractually permitted to walk away from a deal based on a MAC event. In Akorn, the purchaser was able to successfully demonstrate each of the following:
Acquisitions often entail significant financial risk; it is important for transaction parties to be aware of the implications of MAC clauses. The sudden manifestation of the COVID-19 pandemic underscores the paramount importance of MAC clauses and will likely drive transaction parties to scrutinize the applicability, and negotiate the breadth, of such clauses. If you have any questions regarding the content of this article, or MAC clauses in general, please contact any of the authors or members of the Bennett Jones Mergers & Acquisitions team or the Commercial Litigation team. For additional information regarding the COVID-19 pandemic, please see our COVID-19 Resource Centre. Authors
Please note that this publication presents an overview of notable legal trends and related updates. It is intended for informational purposes and not as a replacement for detailed legal advice. If you need guidance tailored to your specific circumstances, please contact one of the authors to explore how we can help you navigate your legal needs. For permission to republish this or any other publication, contact Amrita Kochhar at kochhara@bennettjones.com. |