M&A Transactions: Material Adverse Changes Clauses in Wake of COVID-19

As the COVID-19 crisis hit the United States in March 2020, it caused major interruption for the country’s economy. As the crisis continues to affect daily life, parties who entered into merger and acquisition agreements prior to the crisis may be scrambling to review their agreements to see how exactly COVID-19 impacts their transaction. In particular, parties who have already executed an asset purchase agreement or a stock purchase agreement, will want to pay close attention to Material Adverse Change clauses (“MAC”). While some parties may be quick to invoke these MAC provisions, it is important to consider the legal analysis of such clauses before exercising or initiating any claims related to a MAC clause.

What is a MAC Clause?

The purpose of a MAC clause is to discuss what happens when material change in circumstances of the business occurs prior to closing. This change typically takes the form of a substantial decline in the value or revenue of the business. Typically in asset purchase and stock purchase agreements you will see MAC’s in two contexts, (1) a Purchaser condition to closing and (2) as a Seller representation, representing that no event has taken place that has a material adverse effect on the business. In other words, if there is a MAC, a Purchaser may not be obligated to close, or a Seller may have breached a representation (which allows the Purchaser to go after damages).

Parties will need to look at the specific definition of “Material Adverse Change” as each agreement varies, but typically the definition carves out events due to (i) general economic or political conditions, (ii) conditions generally affecting the industries the Business operates in, (iii) changes in financial or banking markets, and (iv) acts of war. The burning question becomes, should I trigger this MAC clause due to COVID-19? If the entire economy is experiencing these declines, is this change in business circumstances excluded as a material adverse change? These are some of the questions that currently remain unanswered.

What Do Court Say Regarding MACs? How will COVID-19 Affect this Interpretation?

Courts typically will look at the length of time the selling (or target) company experienced the change in financial performance. Purchasers who point only to a short-term value decrease are unlikely to prevail as short term changes typically do not substantially threaten overall profitability of a business. On the other hand, if the change is likely to threaten future earnings by a substantial amount over a long period of time, the claim may be more persuasive. It is difficult to say exactly how COVID-19 will be interpreted regarding the length of value declines. This pandemic still has a lot of unknowns regarding its impact on the economy, including how long these stay at home orders will remain in place, what the economy will look like when these orders are lifted, and how long it will take the economy to rebound to where it was at prior to life with COVID-19. Because of these unknowns, it remains unseen how long these negative economic impacts will continue.

Courts also will look at the intention of the parties as these claims are highly fact specific. At the time the contract was executed, were the parties aware or had discussed the material adverse change? Was the condition generally known? Agreements entered into in December 2019 or January 2020 may not have foreseen this pandemic coming, while agreements entered into March or April 2020 may have. This has yet to be played out in court, but the question of whether parties knew, should have known, or should have anticipated material changes in the economy due to the novel coronavirus is likely to be a very contested issue. This pandemic has evolved so quickly with new developments occurring daily so it remains unclear what courts will do.  

So Should You Invoke a MAC?

There is no one size fits all answer to this question. First and foremost, parties should look to their agreement with their attorney to determine what types of events can trigger the MAC and the likelihood that the consequences of COVID-19 would be included in such event. However, because of all of the unknowns surrounding COVID-19, courts may have various interpretations. Some companies have already invoked these clauses and litigation has initiated, so we may have an answer soon. If possible, it is recommended to engage in discussions with the other party to suggest postponing closing to see what happens in the upcoming weeks or months. If extending closing is not an option, parties should discuss with their attorneys the pros and cons of invoking an MAC and weigh the costs of operating the target company at a loss against the costs of any potential litigation regarding the MAC clause.

Check out the Crow Legal COVID-19 Resource Page for new developments including analysis of any judicial opinions regarding courts interpretation of MAC clauses and COVID-19.