Closing is the expected outcome of M&A transactions, but adverse and/or unexpected circumstances may come into play during the interim period (i.e., the timeframe between signing and closing) and may prevent or make closing no longer desirable. It is in this context that provisions known as material adverse change clauses (“MAC” and “MAC clauses”, respectively) are negotiated and included within the conditions precedent for the closing of M&A transactions.
The purpose of a MAC clause is to preserve the economic foundations of the transaction and help ensure that the parties’ intent and commercial and legal conditions, as formalized in the signed purchase and sale agreement, remain true at the time of closing. A condition precedent of this kind will not be implemented, for instance, if an event sufficiently material and adverse occurs to the target's business, finance, assets or prospects during the interim period, in which case the buyer will be entitled to refuse to comply with its purchase and payment obligations and terminate the purchase and sale agreement. Depending on the occurrence of the MAC and on the parties’ disposition, they may also decide to renegotiate the terms and conditions of the purchase and sale agreement.
Not any event will entitle the buyer to terminate the deal. There are three standard and combining structures for a MAC clause, each of which imply more or less risk allocation to the parties: The first is a broad and subjective definition of what constitutes a material adverse effect, creating room for legal uncertainty. The second adds to the first a presumed amount or threshold for the occurrence of the MAC, e.g., MAC means a material adverse change, provided that it has an impact of at least a certain amount, within a certain time frame. The third, in addition or not to the second, includes specific carve-outs, such as macroeconomic or market crashes, foreign exchange restrictions, legal changes, increased costs, public health issues (e.g., Covid-19) and so on.
Furthermore, the MAC clause can be included on a standalone basis or combined with other conditions precedent. For instance, one can customize a condition precedent relating to misrepresentations, setting forth that this condition precedent shall only be deemed to not having been fulfilled if such misrepresentation characterizes a MAC. Another example is a MAC clause included with the obligation of the seller to conduct the Target’s business in the ordinary course (as verified in the due diligence process) during the interim period, meaning that certain actions or omissions during such period that are out of the ordinary course of business can be characterized as a MAC.
The decision of the Delaware Court of Chancery in Akorn, Inc. v. Fresenius Kabi AG, Quercus Acquisition, Inc. and Fresenius SE & CO KGAA (“Akorn v. Fresenius”) is regarded as a turning point in United States case law on the MAC clause, as it marked the first time a Delaware court awarded a buyer the right to terminate a deal based on the occurrence of a MAC, thereby reshaping the enforceability of the MAC clause. While the bar remains high, it was proven not to be unsurmountable.
In Akorn v. Fresenius, the underlying purchase and sale agreement included extensive representations and warranties on the target’s compliance with the regulatory framework applicable to its business, a covenant for seller to operate in the ordinary course of business during the interim period, conditions precedent that no misrepresentations or breaches of covenants would occur and a standalone MAC clause. Following the signing of the agreement, the target’s market value dropped over 20%, while serious regulatory compliance failures and data integrity violations came to light through internal investigations supported by whistleblowers.
Upon discovering those issues, Fresenius (the buyer) initiated an independent audit and eventually decided to terminate the agreement. On the other hand, Akorn (the target) attempted to compel the buyer to close the deal through specific performance. The court acknowledged that, indeed, there had been misrepresentations regarding regulatory compliance, that the seller had failed to operate the target in the ordinary course of business during the interim period, and that the standalone MAC set forth in the agreement had occurred. Any of these non-compliances on the part of the seller or the verified occurrence of the MAC could have, individually, been legitimate grounds for terminating the deal; interestingly enough, in this case, they coexisted.
Following Akorn v. Fresenius, the court of Delaware took a different direction in Channel Medsystems, Inc. v. Boston Scientific Corporation, NXT Merger Corp (“Channel v. Boston Scientific”). Despite a case of fraud committed by a manager of Channel (the target), revealed between signing and closing, Boston Scientific (the buyer) initially moved on with the deal. In that context, a remediation plan had been proposed by the target and was well received by the competent regulatory governmental authority. Thereafter and seemingly all of a sudden, the buyer sought termination based on misrepresentations by seller that allegedly led to a MAC. In addition to not recognizing that a MAC had occurred, the court held that the buyer had failed to comply with its commercially reasonable efforts to close and was required to close the deal.
More recently, the initially attempted termination of the acquisition of Twitter (the target) by Elon Musk (the buyer) reignited attention around the enforceability and evidentiary burden of the MAC clause in Delaware. The buyer argued that the target had misrepresented the number of spam and bot accounts of the platform, thereby triggering a MAC because the number of monetizable daily active users struck at the core of the valuation on which the deal and its price were agreed upon. The case did not result in a final court decision as the buyer ultimately decided to close the transaction on the trial’s eve.
Case law from the United Kingdom also confirms that the MAC clause should only be enforced where the alleged change affects the target’s financial capacity over a commercially reasonable period, typically measured in years rather than months. A recent example is BM Brazil I Fundo de Investimento em Participações Multistratégia, BM Brazil II Fundo de Investimento em Participações Multistratégia, ANRH Cooperatief U.A. v. Sibanye BM Brazil (Pty) Ltd & Sibanye Stillwater Limited, in which the English Commercial Court dismissed an alleged MAC as a result of a geotechnical event affecting Brazilian mining assets. The court concluded that a reduction in market value in a range of 15–20% could be material, but concluded that materiality is ultimately determined by whether the event has a sustained adverse impact on the target’s ability to generate earnings as a going concern, which was not the case.
Brazilian law has no explicit provisions on MAC and there are no court precedents to bring legal certainty to its interpretation. Brazilian M&A practice generally adopts MAC clauses as a result of the influence of cross-border and international transactions. The challenge is to define the scope and the extension of the interpretation of such a clause in a civil law jurisdiction like Brazil.
Legal provisions most closely resembling the MAC clause are the theory of unforseeability (‘teoria da imprevisão’) and excessive burden (‘onerosidade excessiva’), prescribed by the Brazilian Civil Code. Those are provisions that allow judicial review or termination of agreements when supervening events — regarded as extraordinary, unforeseeable and/or unpreventable, and beyond the parties’ control — cause a significant contractual disbalance. The Superior Court of Justice (Superior Tribunal de Justiça - STJ) has been interpreting these provisions restrictively, requiring proof of (i) extraordinary, unforeseeable and unpreventable events; (ii) severe economic disbalance considering the original terms and conditions the agreement; and (iii) a disproportional advantage to one of the parties.
The Brazilian Civil Code and the Brazilian case law have been evolving to reinforce the autonomy of the parties (‘autonomia privada’), which is, to some extent, favorable for atypical provisions of business agreements. Interpretation of Brazilian law takes into consideration principles of preservation of fairly negotiated and mutually agreed upon contracts and business relationships (pacta sunt servanda).
In an analysis on the occurrence of a MAC, courts will also assess other principles, such as the principle of good-faith and probity, inviting a more comprehensive analysis of the agreement and of the consideration of the parties. Accordingly, good-faith has increasingly been playing a key role in preserving legitimate expectations and constraining opportunistic behavior; it is not merely a moral imperative under Brazilian law. Other provisions can also come into play, such as the verification of latent defects (‘vícios redibitórios’) and/or of lack of sufficient knowledge and/or consent (‘vícios de consentimento’), as well as nullity due to a potestative condition (‘condição potestativa’), i.e., a condition which occurrence hinges entirely on a choice made by one of the parties, rather than on chance or a third party’s action.
MAC clauses under Brazilian law may be innocuous if there are no thresholds or carve-outs. In this case, the choice of adopting the clause or not, despite the autonomy of the parties, can do little to curb legal uncertainty and will certainly require undesired further negotiations among the parties or lengthy and cumbersome disputes.
On the other hand, a more sophisticated MAC clause, with objective thresholds (such as amounts, time frames, qualifiers) or circumstances, and/or well defined carve-outs should represent a legitimate bargain of the parties to be upheld by Brazilian courts. Even in this case, the clause would still be subject to local private law rules and principles and its drafting will require skill, knowledge of the reality of the target’s business and attention to detail. The principle of autonomy of the parties should also play a central role in reducing uncertainties.
Thus, reliance on general legal provisions for risk allocation in the context of an M&A is an ill-advised strategy. The integration of the MAC clause to the agreement may reflect an unquestionable intent of the parties under the Brazilian law. Far from being redundant, a tailored MAC clause can play an important role in protecting the buyer from circumstances that would make the deal less attractive and granting it a potential way-out. Attention to governing Brazilian laws is fundamental to reducing legal uncertainty and increasing the chances of fulfilling the complete scope and reach of what was desired by and negotiated between the parties.