COVID-19: A Material Adverse Change?

[Gaurang Mansinghka is a 4th year student at the Government Law College, Mumbai]

The COVID-19 pandemic has disrupted human life across the globe. Stalled economies, dwindling stock valuations, supply chain disruptions and projections by various organisations indicating a gloomy economic future show that the economic contagion is spreading as fast as the virus itself. This post attempts to answer a pertinent question that dealmakers would ponder upon in these uncertain times: whether COVID-19 can trigger a material adverse change (‘MAC’) clause in corporate contractual documentation.

A MAC provision incorporates events or circumstances which, if they occur, are reasonably expected to have a material adverse change or effect on the target’s business, assets, liabilities, financial condition, operations, or affects the transacting parties’ ability to consummate the transaction. In essence, it helps in allocating and mitigating risk in agreements concerning mergers and acquisitions. A MAC provision operates in the interim period between the time the acquirer has agreed to acquire the business until the time when the business is actually acquired by the acquirer. Typically, a seller would like to narrow the scope of the MAC provision and include carve outs for changes in economic, political, legal or financial conditions, whereas the buyer who bears the burden of proof of proving a MAC would like to enjoy an expansive protection. If the acquirer proves the existence of a circumstance leading to a MAC, it can walk out of the transaction.

Does COVID-19 trigger a MAC?

As a MAC provision varies from contract to contract. There cannot be a “one size fits all” solution and a fact-specific inquiry along with an evaluation of the express language of the MAC provision will help us determine an answer. If the MAC provision does not specifically include thematic issues like pandemics or epidemics, the acquirer will have to gauge the effect of COVID-19 on the target to determine if a MAC has occurred, and if it can be read into the MAC provision of the agreement.

There is a lack of jurisprudence in the Indian context on the said topic, but the closest that the Indian courts have come to in dealing with the aforesaid issue is in Nirma Industries Ltd. v. Securities and Exchange Board of India wherein Nirma Industries had filed an application with the Securities and Exchange Board of India (SEBI) to withdraw a takeover offer (under SEBI (Substantial Acquisition of Share and Takeovers) Regulations 1997) due to the emergence of exceptional circumstances. The withdrawal application was first rejected by SEBI and then by the Securities Appellate Tribunal. Subsequently, the Supreme Court held that an open offer can be withdrawn only if the circumstances render the performance of the open offer impossible on the part of the acquirer. However, it is pertinent to note that impossibility is a higher standard as compared to a MAC provision and the courts may interpret a specifically negotiated contractual clause differently from a statutory provision.

There have been a few instances in the United States where a MAC provision has specifically been adjudicated upon. In IBP Inc. v. Tyson Foods Inc., the MAC provision was silent on whether industry effects were specifically excluded. The buyer wished to trigger the MAC provision because the financial performance of the target suffered due to cyclical effect in the industry. The Court declined to find a MAC and rejected the concept that industry wide factors are automatically excluded from constituting a MAC or automatically qualify as a MAC. The Court observed that a MAC clause is best read as “a backstop protecting the buyer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner.

In the midst of the 2008 financial crisis, the Court of Chancery of the State of Delaware in Hexion Specialty Chemicals, Inc. v. Huntsman Corp  held that, in the absence of the contrary, an acquirer may be assumed to be purchasing the target as a part of a long-term strategy. The target’s failure to meet its financial forecasts by itself will not constitute a MAC, as the merger agreement “explicitly disclaims any representation or warranty by Huntsman” with respect to any projections, forecasts or other estimates.

Further, in Akorn Inc. v. Fresenius Kabi AG, the Delaware Chancery Court determined that a MAC had occurred. It was observed: “A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close.” and that “A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the  longer-term perspective of a reasonable acquiror.”  Therefore, what needs to be considered is the adverse change in the target’s business, which should be ‘durationally significant’ on its earning power. The Court held that a MAC had occurred and allowed the acquirer to walk away from the contract, as the target’s business took a nosedive and its performance had fallen of a cliff (25% decline in revenue, 105% year-over-year decline in operating income) after the parties signed the merger agreement.

In light of the above, it can be concluded that the party claiming MAC will be required to prove that the event which has occurred has caused a change that is so fundamental that it has struck at the root of the contract as a whole and will have a long-term impact. Moreover, a relevant consideration would be whether the event claimed to be a MAC was known or could reasonably be foreseen by the party claiming it and, as a result, agreements entered into prior to January 2020 could be viewed through a different lens than agreements entered into at a later date.

In India, a party seeking a discharge is governed by sections 32 and 56 of the Indian Contract Act, 1872. The parties to a contract may be absolved from further performing their contractual duties if the basis of the contract was frustrated by the occurrence of an unforeseen event (see Satyabrata Ghose v. Mugneeram Bangur and Company). The Supreme Court in Energy Watchdog v. Central Electricity Regulatory Commission has held that the parties cannot be discharged from a contract just because its performance has become commercially onerous. In addition, courts are likely to look at the explicit words of the clause which provides for discharge because the Supreme Court in Energy Watchdog has observed that where the court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself. Therefore, a broadly worded MAC provision may not help the acquirer to walk away from the contract.


The true impact of COVID-19 cannot correctly be ascertained until the dust settles. However, it can be said to constitute a MAC if it has considerable impact on the earning potential of the target, and is likely to have a lasting impact on the operations of the target. Short-term or cyclical difficulty will not be considered as a MAC. If the MAC provision includes a pandemic or an epidemic, it would prove to be favourable for the party seeking to trigger it. Therefore, the wording of the MAC provision should be carefully reviewed. In the absence of a bright-line test, the triggering of a MAC provision will differ from case to case. At present, it is difficult to comment on how courts will view COVID-19 from an impact and duration perspective, as it is almost impossible to predict the path ahead as multiple dimensions of the ‘crisis’ are unprecedented and unknown. It will however be interesting to see how the court interprets the significance of COVID-19 in Omar Khan, S.C.G.C. Inc. v. Cinemex USA Real Estate Holdings Inc. wherein the target has sued its would-be purchaser for specific performance after the purchaser walked away from the closing citing COVID-19.   

Gaurang Mansinghka

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