Does the Material Adverse Change Clause Cover COVID-19?

In mergers and acquisitions, corporate finance and lending, a period of time often passes between signing the applicable transaction agreement and closing the transaction. During the period when the parties prepare for closing, they are subject to any number of risks that could delay or even prevent the transaction from happening.

With the outbreak of coronavirus disease 2019 (COVID-19), declared to be a pandemic by the World Health Organization, the Material Adverse Change (MAC) clause is receiving a lot of attention. Parties to a transaction are questioning whether they are required to proceed with their deals. Is COVID-19 a “material adverse change” sufficient to invoke a MAC clause and terminate a transaction?

Parties to a transaction agreement typically try to assign between them the risks that could delay or prevent a closing through a Material Adverse Change (MAC) clause (sometimes also referred to as a Material Adverse Effect or Material Adverse Event clause). The MAC clause generally allows the buyer, investor or lender to cancel the transaction if a MAC occurs, though in certain transactions (for example, an acquisition where part of the consideration being paid is equity in the buyer) the clause may be invoked by either party.

MAC clauses are usually carefully negotiated, taking into account the circumstances applicable to the parties. The definition of MAC is therefore highly deal-specific and unique to each transaction agreement.

At their core, MAC clauses address an “effect, event, deviation, or change that, individually or in the aggregate, is materially adverse to the business, results of operation or financial condition of the company and its subsidiaries.” From there the parties negotiate carve-outs and exclusions from the MAC.  Buyers and lenders will seek broad MAC clause applicability to maximize their ability to exit the transaction, while sellers and borrowers will seek a narrow MAC clause with numerous exceptions to its use.

MAC clauses manifest themselves in transaction agreements either as a condition to closing, a representation or both. As a condition to closing, if a MAC has occurred, a buyer or lender could choose not to close on the transaction, invoking the condition that no MAC exists as a basis for such termination. As a representation, the seller/borrower can be asked to make a representation that no MAC exists and it can then be the case that if at closing the seller/lender must certify, as a condition to closing, that all representations (including the MAC representation) remain true and correct (and such is no longer the case), the buyer/lender will not be required to close.

To the extent that a MAC clause specifically identifies pandemics, medical epidemics or other viral outbreaks (either as to their applicability or as an exception) as material adverse effects warranting termination, there would be little ambiguity as to the existence of a material adverse change.

If a MAC clause does not explicitly include pandemics, would COVID-19 be a basis for invoking a MAC clause? While this would depend on the specific language of each MAC clause, two typical exceptions to termination may speak to its applicability. First, sellers/borrowers often seek an “Act of God” or force majeure exception – which applies to emergencies, government acts, natural disasters, etc. – to limit the applicability of the MAC clause. (Click here to view a related article.) It may be that COVID-19 falls within such an exception.  Second, a frequent exception is “changes to the national or world economy or financial markets as a whole, or drops in general economic conditions.” Again, the current financial downturn caused by COVID-19 may fall into such an exception.

For now, companies (whether buyers, sellers, lenders or borrowers) should be reviewing any executed transaction agreement for which the transaction has not closed. They should determine whether COVID-19 is covered by the MAC clause and whether the clause covers the impact of the pandemic on the overall economy and/or to the parties to such agreements. Specifically look to see if the financial downturn caused thus far and/or the acts of government taken thus far can be a basis for invoking the clause or fall within negotiated exceptions to the MAC clause.

For future transactions, note the effect of a MAC clause and consider how to negotiate it.

Rivkin Radler’s Corporate Practice Group can guide you through the applicability of COVID-19 to a MAC clause in any of your pending transaction agreements. We will continue to closely monitor the legal and business implications associated with the COVID-19 pandemic and will provide updates as necessary.