Material Adverse Change

When negotiating the purchase or sale of a company, the investor or purchaser will often insist on what is known as a Material Adverse Change (MAC) clause.

This article deals with three issues related to the MAC clause : 1) what is it? 2) When should it be sought by an investor or granted by a seller? 3) What happens if it is exercised by the purchaser?

1) What is it?

A MAC clause is a clause typically requested by the purchaser of a business to be inserted into a Sale and Purchase Agreement (SPA). It states that if the condition of the business being purchased materially deteriorates between the time of signing the SPA and the closing, the investor can call off the closing.

2) When should it be sought by an investor or granted by a seller?

For an investor, the longer the time to closing, or the more volatile the industry of the selling company, the more important a MAC clause may be. The MAC clause helps the purchaser to ensure that he obtains at closing what he signed up for in the SPA. Often, it is accompanied by a final due diligence immediately prior to the closing, or at least the right to obtain certain data in the period between the signing of the SPA and closing.

A seller should only grant a MAC clause if he or she is either very confident that there will be no deterioration in the business in that time, or if he or she is willing to bear the risk of such a deterioration annulling the transaction.

Such a clause essentially means that the risk arising from a deterioration in the business is transferred from the investor (who typically bears such risk after signing a binding SPA) to the seller.

3) What happens if it is exercised by the purchaser?

If the purchaser exercises the MAC clause (typically by providing written notice to the seller or the seller’s legal council), the seller basically has two choices. He or she may either accept the purchaser’s position (in which case there may even be a return of deposit required), or the seller may choose to litigate. The SPA would normally give guidance as to the jurisdiction whose laws will apply, and as to whether the appropriate remedy might be litigation in the court system or arbitration at a body such as the London Court of International Arbitration. Pursuing a legal remedy is not for the faint hearted, and may be extremely expensive.

On the positive side, at least in Anglo-Saxon case law, there is a considerable body of case law on what constitutes a MAC, meaning that a MAC clause is not something that a purchaser or investor can just arbitrarily exercise. There will likely be considerable expert testimony on both sides, as to whether there truly was adverse change, and, if so, whether such adverse change was truly material.

In the event that the court or arbitration panel decides that there was no MAC, there may be either an award of specific performance (i.e. the investor must belatedly complete the purchase of the business), or there may be an award in damages. Because litigation or arbitration typically takes years, and any business typically changes considerably in the course of several years, courts and arbitration panels may lean more towards awarding damages rather than specific performance.

Ultimately, a MAC clause is a reflection of the negotiating strength of the parties in a transaction; an investor can only gain by it but for the vendor it can bring nothing but trouble.

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