M&A transactions, in most cases, require a certain period between signing and closing when the parties obtain approvals from authorities, sellers can secure financing or try to resolve problems, etc. The buyer and the seller signed the agreement in good faith and within their reasonable expectations as good and diligent entrepreneurs, they aim to close the deal as soon as possible. They can try to protect their financial, commercial, organisational expectations during the transitional period in one or more of the following ways:
A seller undertakes to operate the company during this period in a regular manner, to maintain existing commercial relationships and not to enter into any transaction out of the everyday course of business, or above certain material thresholds (or at least not without the consent of the buyer).
Various mechanisms are agreed upon for calculation of the purchase price at closing (depending on the financial parameters during the period from signing to closing).
A buyer is entitled to refrain from closing the transaction if a Material Adverse Change (MAC) has occurred. The absence of a MAC would be a condition precedent for closing the transaction.
The MAC clause would be the last resort for a buyer if unexpected circumstances arise that significantly change or reduce the value of a target company, assets, or business in the period since the signing.
Hence, if the current circumstances (e.g. the COVID-19 pandemic or any of its consequences) would qualify as a MAC under an M&A agreement, the buyer will, at least theoretically, have grounds to withdraw from the transaction or not to close it. The circumstances of real life, however, are usually more creative than any law is able to envisage.
The question is whether a particular circumstance, such as the current pandemic, would actually fall under the agreed definition of a MAC (or a Material Adverse Effect or MAE) within an M&A agreement. The MAC/MAE clause is, as a rule, carefully negotiated and thoroughly defined by the parties because it is always challenging to find a proper balance between a "catch all" clause, which would present a serious, advanced threat to the completion of any transaction, and a detailed definition, which would make it actually inapplicable in real-life scenarios. To view it objectively, a MAC definition usually contains specific value thresholds based on the impact on business, assets, or operations, either in absolute values or in a certain percentage of the transaction value.
As always, there is a possibility that the other party will not accept these grounds, which ultimately may lead to court action or arbitration disputes.
To be considered a MAC, some of the questions pertaining to the COVID-19 pandemic that would arise for consideration before judges and arbitrators around the world include:
Is the situation global and hence, has it put everyone (including sellers and buyers) into a similar objective set-up?
Does it represent a temporary circumstance (i.e. limited in time)?
Does it have long-term effects on a particular sector and the target business and its possibility to recover?
Apart from the particular MAC/MAE clause, an important role in decision-making will be attributed to the rules of the governing law, as set forth in individual M&A agreements.
Fortunately, MAC clauses are rarely triggered in practice as an instrument to withdraw from a transaction since the main target of both parties is always to close the deal because they have already invested significant time, financial, organisational, and planning resources. Although the COVID-19 pandemic (and its scope) could not have been reasonably predicted, it is hoped that this trend will remain the same in the COVID-19 scenario.
Of course, in order to avoid unpredictable and expensive court or arbitration proceedings, the parties can always find and agree on a reasonably acceptable commercial solution for both parties to close or to postpone the closing or to withdraw from a deal depending on the particular case (i.e. the wording of the MAC/MAE clause, agreed financial conditions, etc.).
We encourage parties to try to find and negotiate these solutions, in order to preserve the deals and ensure that the show – and the economic activity – goes on.
For more information on the effect of the current crisis on M&A agreements, contact your regular CMS advisor or local CMS expert Marija Tešić.