November 19, 2008 Private Equity Bulletin MATERIAL ADVERSE CHANGE (“MAC”) CLAUSES IN TODAY’S ECONOMIC CLIMATE Today’s financial climate is volatile. between the time that the agreement is financial investor would be more The country is experiencing the worst executed and the closing. Although the concerned with the company meeting financial crisis in seventy years. What parties define a MAC within the quarterly projections, while a strategic started as instability in the housing agreement, generally a MAC is a change investor would focus on the effect being market has progressed to instability in in circumstances or an event that causes long-term and durational. If a company the financial and stock markets, and a material adverse effect to the business’s is in a volatile or cyclical business, the buyers and sellers alike worry that a deep assets or its financial condition. Some court is unlikely to find a short-term loss recession is looming. Although the MAC clauses focus not only on or a decline in stock price to be a MAC. current administration is working on consequences that occur prior to the Three cases decided by the Delaware various financial rescue packages and consummation of the transaction but Chancery Court, In re IBP, Inc. there are minor indications that the also on consequences that may have an Shareholders Litigation (“IBP”), Frontier Emergency Economic Stabilization Act impact on the post-consummation Oil v. Holly Corp. (“Frontier Oil”) and, of 2008 is having a positive effect on earnings potential of the target company. most recently, Hexion Specialty Chemicals, very short-term lending, it remains A MAC clause typically does not Inc. v. Huntsman Corp. (“Hexion”) , difficult to obtain long-term financing. include changes in political, general provide buyers with direction regarding Understandably, private equity firms are business, economic, or market judicial review and the court’s scrutinizing investment opportunities conditions unless the change affects the interpretation of MAC clauses. and are being extremely cautious until target company disproportionately. The court in Frontier Oil was clear that, the moment that the deal is And, while theoretically a MAC clause unless the burden is contractually consummated. Since sellers have a can include or exclude virtually allocated otherwise, the party that asks minimal amount of leverage in a poor anything to which the parties agree, for its performance to be excused economic climate, buyers have been whether a court will enforce the MAC (usually the buyer) must rebut a strong insisting on agreements that provide the clause is becoming increasingly presumption in favor of closing the buyer with maximum flexibility to walk questionable. transaction. The buyer must away before closing. Until recently, demonstrate that a MAC has occurred The Court’s Analysis buyers believed a MAC clause would and that the effect is material. The In analyzing whether a MAC has protect the buyer from unforeseen events “materiality” inquiry is highly fact occurred, a Delaware court will first or circumstances; however, recent specific and will, of course, depend upon consider whether the event or decisions by the Delaware courts have the circumstances of both the circumstances were included under the shaken this belief. transaction and its parties, as well as the MAC clause and whether the possibility language chosen by the parties in the MAC Clauses and Adverse of the event or circumstances was MAC clause. In Frontier Oil , the buyer Conditions disclosed at the time that the parties showed that the litigation in question A MAC clause is a tool believed to entered into the merger agreement. A could have a material adverse effect on allocate economic risk among the court will then strictly construe the the target business going forward, but parties. In general, a MAC clause allows MAC clause and make a fact based the buyer failed to show that the the buyer to terminate an agreement if inquiry focused on the intent of the litigation “[did] have, would have, or there is a material adverse change that parties at the time that they entered into would reasonably be expected to affects the target company or its assets the merger agreement. A short-term
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