COVID-19 and Material Adverse Change (MAC) from the perspective of M&A

In light of the COVID-19 pandemic, some parties to M&A agreements, especially in those sectors particularly affected by the virus containment measures, have been forced to start thinking about how to adapt their contractual commitments to changing economic conditions. One of the provisions that is regularly included in M&A agreements and actually allows this is the Material Adverse Change (MAC) provision. Although these provisions differ significantly from one agreement to the other, they generally allow a buyer who has otherwise signed an M&A agreement to avoid its performance (ie, transfer of business share, business, etc. and to thereby avoid fulfilling its obligation to pay the purchase price) by unilateral termination of the agreement if certain circumstances occur that affect the operation of the target to such an extent that the buyer cannot achieve the purpose of the agreement.

Due to the right they include and its far-reaching consequences, the MAC provisions, like the correlated legal construct of dissolution or amendment of an agreement due to changed circumstances (Article 112 et seqq. of the Slovene Code of Obligations), should be interpreted as narrowly as possible and used only when changed circumstances and their significant impact on a particular contractual relationship have been convincingly demonstrated.

Accordingly, it is not surprising that in many M&A transactions, sellers find it difficult to agree to MAC provisions, which leave them bearing a significant part of the risk of unforeseen deterioration of the target’s condition at a time when the M&A agreement has already been signed but not yet implemented (closed). This is all the more pronounced in cases where the buyer wishes to negotiate a more general MAC provision covering a wide range of events and circumstances. In consequence, the sellers usually demand that the scope of the situations covered by the MAC provision is as narrow and specific as possible (eg, decrease in EBITDA by a certain value), that short-term events (eg, with duration shorter than three months) are excluded, and that the onset of a material adverse change is confirmed by, eg, an independent expert. However, such detailed provision will also have positive effects for the buyer – in the case of a judicial or arbitral intervention in respect of the withdrawal from the agreement, it will be much easier to prove that there are specific circumstances that justify such withdrawal, and, in consequence, that the buyer has validly withdrawn from the agreement. What is more, in order to balance the competing interests, the parties often agree on a break-up fee, which reduces the buyer’s motivation to withdraw from the agreement.

Despite resistance of sellers to include MAC provisions in M&A agreements, the pandemic of the new coronavirus can be expected to lead to their (more) widespread use (in varying contents, depending on the bargaining powers of parties and the specifics of individual business sectors).

It is also interesting to distinguish between the MAC provisions in the M&A agreements concluded before the outbreak of the new coronavirus and those concluded after it. Namely, most of the “classic” MAC provisions do not cover material adverse changes that concern the entire industry or even broader market conditions (as opposed to individual companies). The effects which the new coronavirus pandemic has had or is having on the markets are therefore, as a rule, explicitly excluded from the scope of (existing) MAC provisions. On the other hand, the contractual freedom allows parties of new M&A agreements to allocate the risk posed by the changed business conditions for the target’s operations at their own discretion. Appropriate contractual regulation of this issue is also important considering that the new coronavirus represents a circumstance that the parties may or even have to take into account when concluding an agreement, which means that the dissolution or change of the agreement on the basis of the law itself (ie, Articles 112 et seqq. of the Slovene Code of Obligations) will generally not be available. Since the outbreak of a pandemic is already a known circumstance, it might be advisable for the parties of new M&A agreements to focus on what constitutes a “material adverse change” in the target, based on which the buyer will be allowed to unilaterally withdraw from the agreement.

Where the purchase price is financed by a loan, special attention should also be paid to ensuring that the MAC provision in the M&A agreement is in line with the MAC provision (if any) in the loan agreement, as this will allow the buyer to avoid a situation where the lending bank may cancel the loan, whereas the buyer will still be obliged to pay the purchase price under the M&A agreement.

Considering all of the above, there is one of very important weaknesses of the MAC provisions which should not be overlooked: if the parties agree that this provision will be included either as a negative condition precedent for the completion of the transaction or as an independent right of withdrawal, this may result in several years of an ongoing dispute, during which it remains completely unclear in what way and with what restrictions the seller should manage the target.

As there is no single answer to the question of whether the outbreak of COVID-19 constitutes an appropriate trigger for the withdrawal from the agreement based on a MAC provision, and, at the same time, MAC provisions in the post-COVID-19 period must be adapted to the specifics of each target, its business, etc., a careful analysis of all the circumstances of an individual case or transaction, as the case may be, is required in order to ensure an optimal solution regarding the MAC provision in an individual M&A agreement.

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Law firm Sibinčič Novak & Partners
Dalmatinova ulica 8
SI-1000 Ljubljana, Slovenia

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