[Sridutt Mishra is a 4th year student and Apoorva Upadhyay a 3rd year student, both at the National Law University Odisha]
The fear over the spread of Covid-19 has wreaked havoc on the global economy, with initial estimates suggesting an even worse impact than the 2008 Global Financial Crisis and the Great Depression. Central banks and securities regulators across countries such as India, the United States and the United Kingdom have relaxed their regulatory norms, and provided conditional regulatory relief and assistance to companies that are affected by Covid-19.
As a consequence, corporate deals are also facing the brunt, with one of the first victims of the pandemic being Xerox’s takeover of Hewlett Packard (HP). In November 2019, Xerox set its sights on HP, and sought to take it over in a strategic move to unite two of the tech world’s fading stars. However, after HP rejected Xerox’s takeover bid twice, Xerox in January 2020 officially announced its plan on a hostile takeover by nominating 11 new directors to replace the entire board of directors of HP, thus triggering a proxy war. The potential takeover was, however, hit by the unprecedented circumstances arising from the Covid-19 outbreak. Within 15 days of the offer, Xerox decided to put a halt on its effort to acquire HP, and later on decided to drop the hostile bid entirely.
Desperate Times Call For Desperate Measures
In such extraordinary times, a pertinent question arises regarding the countermeasures a company can deploy to cut their losses. In mergers and acquisitions (M&A) transactions, securities issuance and debt financing, one of the most hotly contested aspects, across jurisdictions, in recent times has been the material adverse change or “MAC” clause. If an event occurs that materially changes the circumstances under which the transaction had originally been proposed, the obligor is given an opportunity to exit because of such material change. Similar to a force majeure clause in a contract which absolves liability of both the parties, or suggests alternative remedies such as partial performance or renegotiation of the contractual terms on happening of an event which changes the contract equilibrium, MAC clauses allow the party to walk away from the transaction considering the change in the commercial environment. The MAC clause, therefore gives a unilateral right to the adversely affected party to rescind the contract obligations thereby protecting themselves from the adverse consequences of the unforeseen event, like Xerox in the above stated scenario.
MAC Clauses: Lessons from the Past
MAC clauses are now a common feature of commercial transactions and feature regularly in commercial contracts. However, there continues to be a lack of clarity through robust parameters under law as to what would constitute a material adverse change.
Financing commitments are usually heavily negotiated; however, the MAC clauses drafted can often be ambiguous and are often subject to multiple interpretations. The clause tends to cover the assets of the borrower and its ability to meet obligations. Upon disbursement, MAC clauses usually focus on the enforcement of the securities. The UK High Court of Justice in Grupo Hotelero Urvasco SA v. Carey Value Added (2013), a case that dealt with a general deterioration of the borrower’s financial position, adopted an objective standard to determine which change shall be considered as material and trigger the MAC clause. The Court opined that it has been the practice of English courts to give a literal interpretation of what has been stipulated in the agreement. The Court laid down certain valuable principles to interpret MAC clauses: the material change must not be temporary, it must affect the borrower’s ability to repay the loan and it should not include circumstances that were foreseeable by the lender.
In the M&A landscape, established jurisdictions such as that of Delaware in the United States have wrestled with MAC clauses for over a decade now. The landmark case for interpreting MAC clauses is IBP Inc v. Tyson Foods Inc, where the Delaware Court of Chancery observed that the MAC clause is essentially a backstop that safeguards the buyer from the adverse outcomes of unknown occurrences, which jeopardise the overall earnings potential of the target company in a durationally significant manner. Additionally, the Court also observed that a MAC must not be transitory, reasoning that a short-term blip which would not affect the long-term earnings of a target would not be considered material. Similarly, in the UK as well, the Takeover Panel has held that meeting this requirement necessitates an adverse change of very considerable significance striking at the very heart of the transaction in question, similar to frustration of a legal contract.
Typically, in a transaction, the MAC clause is a “catch-all” concept designed to capture unpredictable and unforeseen events or circumstances that would otherwise be difficult to legislate or contract for specifically. However, considering that commercial agreements are of contractual nature between the parties, more often than not, the court’s construction of a MAC clause is fact and language-specific, making litigation outcomes difficult to predict.
As commercial practice would suggest, a typical MAC clause would generally include within its field of range ‘financial position and prospects’, ‘trading position’ and ‘market conditions’.However, as discussed above, simply including these terms would not be sufficient to absolve the party from their obligations until the adverse impact is proven to be for a durationally significant period. To absolutely ensure that an event like the Covid-19 can be considered as a ground for establishing the material adverse effect, the clause must be precisely drafted, incorporating terms like epidemics and pandemics within its ambit.
Therefore, the question of material adversity is a tricky one and its answer largely depends on the particular industry it concerns. For instance, event management businesses have largely stopped all activities and the material effect on that industry is self-evident. Conversely, this issue is not necessarily applicable to other industries – certain healthcare providers, for example. Additionally, there also exist geographical aspects to this issue. A business in a “hot spot” such as Italy or Spain is more likely to have a MAC issue and all these will have to be determined on a case-to-case basis.
In financing transactions, the lenders might not consider COVID-19 as a MAC event on account of it being the sole reason for change in the economic condition of the borrower. However, the position may be different if an already struggling business has been pushed to the point of no return.
– Sridutt Mishra & Apoorva Upadhyay