The Covid-19 pandemic changed the world on many levels. Seen within the context of the various public health measures governments around the world have taken, such as curfews and lockdowns, which effectively hindered commercial activity, the pandemic continues to have an impact on the negotiation process and the conditions under which mergers and acquisitions take place. Both buyers and sellers, as part of their respective strategies, would benefit from factoring such circumstances into their negotiations, as well as weighing the potential risk of a new pandemic in the future. One of the means of protection from these types of unpredicted setbacks available to the buyer in a M&A operation is the Material Adverse Change clause, which we will briefly explore in this article.
introduction of Material Adverse Change clause (MAC)
In the context of a merger or acquisition, a Material Adverse Change clause (MAC) is designed to give the buyer the right to walk away from the acquisition before closing if uncontrollable events occur that are detrimental to the target company.
The MAC itself has a long history, originating in Anglo-Saxon law, the body of legal principles that prevailed in England from the 6th century until the Norman conquest.
Events which typically allow a buyer to implement a MAC clause are those that are unforeseen by the involved parties at the time of the contract signing.
MAC clauses typically stipulate that the unforeseen event allowing for the implementation of this clause must have a significantly unfavorable impact on the target company or on the acquirer (for example, such as on the ability to obtain the financing to complete the acquisition).
The materiality of the impact will be assessed objectively (via accounting or financial thresholds stipulated in the contract) or subjectively (and the margin for interpretation demonstrating the materiality of the impact will be larger). In any case, the buyer will have to provide proof of the occurrence of the unfavorable event.
The materiality of the impact will then be evaluated, on the one hand, with regard to the sector of activity of the target, its business model or the type of its suppliers and, on the other hand, according to its sustainability (a temporary drop in the target’s turnover cannot be considered as a significant event).
This latter assessment has beed adopted by Louis Vuitton SE (LVMH), in its renegotiations of the Acquisition deal of Tiffany & Co (see Case Study below).
To summarize, there are typically 3 criteria that trigger the application of a MAC clause:
1. The event in question has a significant unfavorable impact on the operation of the target business;
2. The event in question is unforeseeable, irresistible and uncontrolled by the parties;
3.The buyer provides proof of the occurrence of the unfavorable event as defined in the clause;
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Contact UsA Case Study in MAC Clauses: LVMH/TIFFANY & CO.
In perhaps what one might consider a case study in the use of MAC clauses, Moët Hennessy Louis Vuitton SE (LVMH), one of the world’s leading luxury products groups, was recently confronted with a difficult application of a MAC Clause in the process of acquiring Tiffany & Co.
LVMH-Tiffany deal’s MAC clause contained a list of events (exclusions) making the clause inoperative, among which force-majeure events like “natural disasters” and “acts of God”.
A pandemic may actually be included in such categories since it is an external, unpredictable and irresistible event.
Thus, when LVMH claimed the application of the MAC clause in order to renegotiate the deal for a lower price of acquisition because of the huge disruption caused by the pandemic to the target business, Tiffany pointed to the force-majeure exclusion since the Material Adverse Change in question arose out of a “natural disasters” and the MAC clause does not cover such unpredictable events.
For these reasons, according to Tiffany, LVMH had no right to claim the application of the MAC clause and renegotiate the price of the acquisition.
However, LVMH eventually won the negotiation with Tiffany arguing that the wording of the MAC Clause included in the Acquisition Agreement did not exclude its application when the force-majeure, such as a pandemic, is so disruptive that makes the entire operation void from a business point of view.
LVMH made a $15.8bn (€15.033bn) deal, significantly lower than the initially announced $16.2bn.
The main takeaway of this case is that the buyer can still renegotiate or walk away from a deal claiming the application of a MAC clause when this clause contains a provision that the “Major Adverse Change”, although depending on an event of force majeure, may make the deal totally unprofitable.
Points of consideration when writing MAC clauses
It is in the interest of the parties to provide for a delimited clause, in particular by inserting materiality thresholds. A MAC clause that is too broad is a source of insecurity for the seller and could be declared null and void for potestativity to the detriment of the buyer.
On the contrary, a precise clause will have the advantage of a quasi-automatic application, leaving little room for interpretation.
The insertion of thresholds will either facilitate or limit the bringing into play of the MAC clause, the buyer having an interest in negotiating a low threshold and the seller a higher threshold.
Thresholds are used to quantify the impact of an event or to delimit the duration during which it must be observed in order to lead to the application of the clause.
Last but not least, as we have seen in the LVMH/TIFFANY & Co. case study, when the MAC lists, by way of exception, the incidents excluded from the definition of the significant event triggering the MAC clause, it is in the acquirer’s interest to provide that those exclusions will be inoperative when the business target is affected disproportionately by the event initially excluded.
Indeed, LVMH won the case thanks to a well-structured MAC clause that set out that force majeure does not exclude its application in case the event is so disruptive that makes the entire operation void from a business point of view.
Conclusions
It is a significantly beneficial strategy to include a MAC clause in an Acquisition Agreement which properly specifies the conditions and/or thresholds allowing an event to be considered significant.
MAC clauses are complex and need to be drafted very precisely.
Failure to correctly draft a MAC clause may result in its ineffectiveness, as well as potential future disputes between the parties. While no one can predict the future, one should always prepare for it.
MAC clauses can be invaluable to the parties to regulate the uncertainty inherent to complex transactions as mergers and acquisitions.
The opinion expressed in this article is for informational purposes only.
This article does not constitute legal advice.
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