Material Adverse Change (“MAC”) provisions are significant in merger and acquisition agreements because they provide particular circumstances which allow one of the parties to terminate the agreement between the signing and closing of a merger or acquisition. These clauses are also prevalent in other instruments such as financial agreements, commercial contracts and investment agreements, and others. A recent decision from the Delaware Court of Chancery, Akorn v. Fresenius, has serious implications for the future of MAC clauses and anyone who utilizes them.
The court in Akorn stressed that contracts should be interpreted using the plain language of the agreement and not “read in” concepts that are not specifically provided for. Going forward, parties should not rely on standard “form” MAC clauses and should explicitly address any and all issues and concerns. Further, parties must not rely on “standard” MAC definitions. Rather, parties must seriously consider what events or changes must occur to trigger MAC provisions, or if the reasonable expectation of certain events is sufficient. The definition of “materiality” must be crystal clear as well. All general and specific risks must be analyzed and the parties must negotiate how to apportion the risk.
The apportionment of risk requires assessment of both company-specific and industrywide conditions. Acquirers have an interest in ensuring that the MAC provision covers industrywide conditions with a disproportionate effect on the target. On the other hand, the target will want to ensure that any exclusions for industrywide changes, such as new competition or regulatory crackdown (including a timeframe for regulatory approval), are drafted as broadly as possible. Other considerations include risks that are generally “known” by industry insiders, risks disclosed in due diligence, set forth on a schedule to the agreement, or disclosed in the target’s public filings. Also, both parties must consider whether the agreement should provide for “access rights” to allow the acquirer to investigate potential issues and, if so, what the limits of those rights should be. An experienced M&A attorney can help you deftly navigate the tricky landscape of risk apportionment.
Obligations by the parties to attempt to complete the transaction, known as efforts obligations, also received scrutiny by the court. Without further definition, the court suggested that all efforts obligations could impose a similar obligation, that all reasonable steps must be taken to consummate the transaction. However, some parties desire stricter standards, such as “hell or high water” commitment and intend for that standard to require actions beyond those that are “commercially reasonable.” Stricter standards must be expressly provided for in the agreement.
During the negotiation process, parties should consider to what extent the target must continue to operate its business in the ordinary course, consistent with the target’s past practices. The agreement could also bind the target to operate in the ordinary course that would be expected of a hypothetical, similarly situated company. The parties should consider whether there are any particular actions that the target must or must not take to satisfy the “ordinary course” requirement and the effect of extraordinary events like natural disasters and whistleblower activity. These “ordinary course” requirements are especially important for financial buyers because many of them are focused primarily on short-term gain, shortening the “durational significance” of any material changes.
Finally, the court addresses some concerns in the event that a MAC occurs. Akorn is a reminder that parties must consider the relationship between the drop-dead date and right of the target to cure failures. Whether the right to cure can be exercised until the drop-dead date or of the failure must be cured by that date must be explicit in the agreement. If the target fails to cure and the acquirer decides to terminate the agreement, the parties must look to any termination rights provided in the agreement. These rights must be provided for by contract and generally do not allow the terminating party to terminate if that party is in breach of the agreement. Whether that breach must be material or not is up to the contract and is something that your M&A attorney can help you navigate.
The Akorn case reinforces some longstanding concepts but also provides some clarification on how courts interpret and apply MAC clauses. Though important, these clauses can quickly become convoluted and complicated. We encourage anyone dealing with these agreements to reach out to our experienced team of M&A professionals to help guide you through the process.
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