Introduction
Material adverse change (MAC) clauses have been dealt with an increasing care throughout the years by law practitioners. This increasing trend echoed and amplified both through domestic or global economic struggles, through the Covid-19 pandemic, armed conflict between Russia and Ukraine, high inflation, currency fluctuations and strict sanctions regimes of various countries. Due to its contractual nature, a claim for occurrence of a material adverse change is heavily dependent to the contract the claim based on and wording therein. As a concept that had flourished in the practice of multinational contracts, the MAC clause may have different legal ground in number of jurisdictions.
This article efforts to provide a Turkish-law perspective to such international phenomenon by underlining the difference between similar legal concepts and explore different approaches to the MAC clause through a couple of exemplary provisions. Although the MAC clause is extensively visited in banking and finance law, namely under loan agreements, this article would focus on merger and acquisition agreements as an anchor. Written in a year, in which the Covid-19 pandemic is no longer a novelty, this article would not focus on merely the theme “MAC clauses and the pandemic”, but rather the characteristics of a MAC clause, legal base of a party’s claim in relation to the MAC clause and evolvement of such living provision.
MAC Clauses under Different Concepts of a Contract
As a concept that is driven in contract law practice, and specifically for contracts that require a substantive investment from one of the parties, a MAC clause mainly serves as a tool for risk allocation.[1] Such risk is the occurrence of an adverse change in the timeframe within the obligatory act (i.e. signing) and the dispositive act (i.e. closing), or in some cases for a period after the dispositive act. The common usage of a MAC clause is yet to mean that it is stipulated in a unified manner. For instance, a MAC clause is sometimes incorporated under a share purchase agreement, as a negative condition precedent to the closing. In such cases, the parties agree that the closing would be completed only if the MAC event had not occurred.
Alternatively, parties may also incorporate a MAC clause to the contract as a representation or warranty under representations and warranties. In this regard, seller may give a representation as of the signing date that no MAC has occurred or nothing leading to a MAC has occurred.[2] For a similar effect as a condition precedent, seller may give a warranty that no MAC would occur between the signing and the closing, which would be of non-repeating nature. Whereas, if the seller gives a warranty that a MAC would not occur the closing and also until the first anniversary of the closing, this repeating warranty would elongate the timeframe for occurrence of a MAC, beyond the closing. Although such elongated timeframe could be adopted between the parties, in share purchase agreements, the allocated risk is usually limited up to the closing, to mitigate the interim period risks on the parties and the target business.
Lastly, it is also possible for parties to adopt the MAC clause, apart from the article on representations and warranties and also from conditions precedent. As it may be governed under a separate article, a MAC clause could be incorporated among the circumstances entitling the buyer to avoid or terminate the contract.
Differences from Similar Legal Concepts under Turkish Law
Similar to laws of Continental European countries, under Turkish law there are two main concepts to remedy the circumstances arisen after the contract is concluded. These two concepts are namely impossibility of the performance and the hardship.
Impossibility
Impossibility has its routes from Roman law concept, force majeure and requires the performance become either physically or legally impossible. For all three concepts, impossibility, hardship and MAC clause, the chronological order between the conclusion of the contract (the obligatory action) and the occurrence of the subsequent event is of critical importance. For instance, if the performance was already impossible at the signing of the contract, then Turkish Code of Obligations numbered 6098 (“TCO”) Article 27 deems the contract void ab initio. However, when such impossibility occurs after the execution of the contract, then such circumstance would be dealt under Article 136 of the TCO. Article 136 of the TCO has different divisions, first for full impossibility or partial impossibility; second for impossibility caused by the debtor and by the factors other than the debtor.
The resembling version of impossibility to MAC clauses, is the type of impossibility regarding the performance of the contract which arises after the contract is executed, due to a factor other than the debtor herself. Article 136 of the TCO rules that if the performance of the obligation becomes impossible for reasons for which the debtor could not be held responsible, the debt ceases to exist, ipso jure. Within the context of share purchase agreements, such impossibility may be exemplified as a legislative prohibition to share transfer for companies at a specific sector, or to share transfers to the non-nationals for a period of time, for a deal targeting acquisition of a Turkish mining company shares by a foreign investor.
The two main differences between impossibility and a MAC clause under Turkish law could be detected from the Article 136: (1) for impossibility, near-to-objective level of impossibility is required, whereas for material adverse change, the performance may well maintain its possibility, and (2) when the performance becomes impossible, the obligation ceases to exist ipso jure, whereas a MAC clause would entitle one the right to avoid the contract, exercise of which remains at their discretion.
Hardship
Hardship is not only a concept governed under Turkish law of obligations but also has been subject to unification efforts, namely by the ICC through its model clauses.[3] Unlike the impossibility, the performance of the obligation had not become objectively impossible, however became excessively onerous for the debtor, due to an event beyond its reasonable control. The concept of hardship, by moving away from objective or near-to-objective concept of impossibility and landing at the quasi-subjective territory of onerousness for the debtor, brings the jurists to struggle to find the “golden medium” between the principle pacta sunt servanda versus principles of fairness and reasonableness.[4]
Under TCO, the hardship is remedied primarily as a request to adapt the contract to restore the equilibrium and secondarily as avoiding the contract (or when appropriate, terminating the contract) if the following criteria are met cumulatively: (1) emergence of an extraordinary situation, (2) that was not foreseen by the parties at the time the contract was concluded and was not expected to be foreseen, (3) arising for a reason not caused by the debtor, (4) changes the facts existing at the time of the conclusion of the contract to the detriment of the debtor to the extent that it would be contrary to good faith to request the performance, (5) the debtor has yet performed their obligation or has performed it reserving their rights arising from the hardship.
Again, there are two main differences between the concept of hardship and MAC. First, as a statutory concept, the hardship provision under TCO requires an extraordinary situation that is unforeseeable by the parties, whereas for a MAC clause parties are only required to stipulate the “change” that they attribute a material adversity to, which is neither required to be extraordinary nor unforeseeable. Second, primary remedy for hardship is to request adaptation of the contract as per TCO Art. 138,[5] whereas under a MAC clause the primary remedy is the avoidance of contract generally, without any prejudice to parties’ contractual freedom to stipulate a negotiation phase for adaptation.
Lastly, force majeure and hardship allow for termination after signature and regulate the conditions of termination. On the other hand, MAC clauses grant the right to avoid the contract rather than termination, and the exercise of this right would not bear the consequences of termination; in this respect, it allows to walk away.
Material Adverse Change Clause and Examples
The MAC clause specifically addresses certain needs in an investment deal, namely a share purchase agreement, by not discussing the impossibility of the performance, by not requiring the circumstance to be unexpected, extraordinary or unforeseen, by not forcing parties to negotiate an adaptation to the contract or accept an adaptation by a judge or an arbitrator. In this regard, the MAC clause differ from force majeure and hardship, as the MAC event may well be ordinary or foreseeable. The MAC clause, entitles the buyer (or in some exceptional cases, the seller) to merely walk away before the closing is completed. Such option to walk away, legally through avoidance of the contract, equips the parties with a quite straight-forward tool to deal with a material adverse change in the interim period. To clear the choice of legal terminology, the avoidance of the contract (sözleşmeden dönme in Turkish law) has retrospective effect as to invalidity of a contract, whereas termination invalidates the contract prospectively.
Although what constitutes a MAC for each deal should be defined meticulously under each share purchase agreement, scholars provide a basic definition as follows: “means any material adverse change in the business, results of operations, assets, liabilities, or financial condition of the seller, as determined from the perspective of a reasonable person in the buyer’s position”.[6] Such basic definition, may serve the purpose of understanding the purpose of having a MAC clause, however due to the high tendency of a dispute on the scope of a MAC definition, market practice has led to specific definitions for what would constitute a MAC under each deal.
In some transactions, the general economic situation of the country, currency fluctuations or inflation may be the motivation for stipulating a MAC clause, while in some deals, the risk of loss of value for the target company becomes the motivation. Loss of value for the target company may be exemplified as loss of value in the stock market, cancellation of license, cancellation of concession or incentives. Some of the example MAC definitions from previous experiences are quoted below. First, an exemplary MAC clause focuses on the EBITDA of the target company and sets a fixed threshold of 20%, inter alia:
“Material Adverse Change means any event, change, circumstance, effect, development or state of facts (whether specific to the applicable party or generally applicable to multiple parties), violation, inaccuracy or other matter that has, or would, individually or in the aggregate with other events, reasonably be expected to have or give rise to, a material adverse effect on or material adverse change to the condition (financial or otherwise), business, results of operations, assets, contracts, or liabilities of the Company, which causes the EBITDA of the Company fell by more than 20% until the Closing Date , including, but not limited to, any act of war involving or ongoing within the borders of Turkey; any material change in Taxes; or any of the Management Shareholders losing their legal capacity, competence or ability to perform their duties concerning or related to the Company as reasonably expected from them, due to a disease or otherwise; in each case, permanently.”
Another example is from a share purchase deal where acquisition of shares is motivated by a financing of a project to be conducted through the target company, but the seller’s contribution and commitment to the project is of critical importance. Therefore, the MAC definition refers to the target company and the seller as well as the financing agreements, all together:
“Material Adverse Effect” means a material adverse effect on:
(a) the ability of the Seller to substantially perform or comply with any of its obligations under any Financing Agreement;
(b) the legality, validity, enforceability and binding nature of any Financing Agreement or Project Agreement or the legal rights, remedies and priorities of the Buyer under any of the Financing Agreements;
(c) Target Company’s or the Seller’s ability to implement or operate the Project substantially in the manner contemplated by the Financing Agreements and the Project Agreements; or
(d) Target Company’s or the Seller’s business, operations, property, financial condition or prospects.”
Lastly, a more traditional MAC definition may take a fixed amount of loss to be realized by the target company until the closing:
“Material Adverse Effect shall mean any material adverse change in or effect on the Business, assets, liabilities, results of operation, condition (financial or otherwise) or the immediate foreseeable prospects of the Company which have resulted in the Company suffering Losses equal to or greater than USD … (… US dollars), or any litigation or Tax investigation, Tax assessment made by a Governmental Body, Tax levy equal to or greater than USD… (… US dollars) against the Company or any material adverse change in or effect on (including any material delay) the ability of the Existing Shareholders to perform their obligations hereunder.”
Without any doubt, it is not possible to give examples for MAC definitions in an exhaustive manner. Domestic financial dynamics in each jurisdiction, such as currency fluctuations, and global trends, such as compliance to the carbon emission policies, may have a crucial role in a MAC definition.
Legal Consequences of MAC
As explained above, a MAC clause, entitles the buyer with an option to avoid the contract, which practically serves as a way to walk away from the deal. The avoidance of contract is governed by Article 125 of the TCO under Turkish law. However, Article 125 entitles a party to avoid the contract when the other party is in default to perform its obligation, upon the expiry of the extension of time by the non-breaching party. Thus, avoidance on the basis of MAC, is not regulated under Article 125, rather the parties create a contractual right to avoid contract by stipulating a MAC clause.
Although being a contractual right to avoid a contract, the legal consequences would remain the same as the statutory option to avoid a contract. As per Article 125 of the TCO the creditor, by notifying a waiver on their right to demand the performance of the obligation, may claim compensation for the loss due to the avoidance of the contract. In the event of avoidance of the contract, the parties are mutually released from the obligation to perform and shall return the previous performances. Since in the case of MAC clauses, the buyer would be expected to use its option to avoid contract before the closing is completed, the requirement to return previous performances would not result in substantive obligation. Any penalty fees agreed by the parties would be applicable aside from the consequences of avoidance.
Conclusion
Importance of meticulously drafted MAC clauses has been acknowledged while going through domestic and international financial crisis in the last decades, alongside with global pandemic of the recent years. Understanding the purpose and aim, legal nature and consequences of a MAC clause in each jurisdiction requires to explore the MAC clause by comparing it with the already governed legal concepts. For the case of Turkish law, the similar legal concepts are impossibility and hardship clauses, both differentiating from a MAC clause either by its requirements and/or its remedies.
MAC clause should be drafted and negotiated very carefully as it gives the right to walk away without any liability, even if all conditions precedents are fulfilled, and even if there is neither impossibility nor hardship for the closing of the contract. From the seller’s perspective, MAC clauses containing generic and ambiguous wording should be avoided and the MAC events that grants the right to avoid the contract to the buyer, should be listed as specific and objective as possible.
As it provides a contractual remedy to avoid a share purchase contract, each MAC clause should be drafted by regarding the specifications of each deal, target company, parties, and the relevant jurisdiction. These factors may lead to defining the “material adverse change” based on a decrease in target’s EBITDA, or as a certain amount of loss realized by the target company, or by non-compliance of the seller under the project agreements, or based on currency fluctuations. Under Turkish law, the occurrence of a MAC, entitles the buyer to avoid the contract, which would release them from their obligations, entitle them to claim the loss due to the avoidance of the contract, and if agreed by the parties, a penalty fee.
[1] Adam B. Chertok, “Rethinking the U.S. Approach to Material Adverse Change Clauses In Merger Agreements”, University of Miami International and Comparative Law Review, Vol. 19 Issue 1 (2011) p. 100.
[2] Kenneth A. Adams, “A Legal Usage Analysis of "Material Adverse Change" Provisions” Fordham Journal of Corporate & Financial Law, Vol. 10, Issue 1 (2004) p. 10-12.
[3] The model hardship clause by International Chamber of Commerce (ICC) under Hardship Clauses March 2020 (“ICC Hardship Clause 2020”) could be accessed through https://iccwbo.org/content/uploads/sites/3/2020/03/icc-forcemajeure-hardship-clauses-march2020.pdf. For further reading on the ICC Hardship Clause 2020, please see. Ercüment Erdem, “An Update from the ICC: The ICC Force Majeure and Hardship Clauses 2020”, Erdem & Erdem Newsletter, March 2020, https://www.erdem-erdem.av.tr/en/insights/an-update-from-the-icc-the-icc-force-majeure-and-hardship-clauses-2020.
[4] Rona Serozan, “General Report on the Effects of Financial Crises on the Binding Force of Contracts: Renegotiation, Rescission or Revision”, General Reports of the XIXth Congress of the International Academy of Comparative Law Rapports, Springer, 2017, p. 102.
[5] This evaluation is made on the basis of Turkish Code of Obligations. For a more flexible hardship clause which leaves the choice for primary remedy to the parties, please see. ICC Hardship Clause 2020. The clause has been drafted to alternate between remedies such as “party to terminate”, “judge adapt or terminate” and “judge to terminate”.
[6] Adams, p. 21.