Recently Quadrant Private Equity walked away from a circa $250 million deal to acquire Total Tools by invoking the material adverse change condition precedent in the transaction documentation. This is unlikely to be the last merger casualty of COVID-19, with others left to wonder what this means for their transaction or commercial contracts in general.
What is a MAC clause?
Even outside the private equity context, it is common for a purchaser to seek the inclusion of a condition precedent to transaction completion that there has been no material adverse change to the target business since the time of signing the relevant sale agreement.
A vendor will want to ensure that the satisfaction of the condition does not rely on the opinion of the purchaser as to whether an event has occurred which constitutes a material adverse change. For this reason, it is common for such provisions to be confined to matters having a measurable financial impact above an agreed threshold, such as a negative impact on earnings (e.g EBITDA or revenue) or net assets.
A vendor will also want to exclude any negative impact on the business resulting from general economic or industry conditions, in that the event must be specific to the business.
While vendors generally try to resist any condition precedent of this nature, vendors generally accept them on the basis that the vendor remains in control of the business until completion and is generally entitled to the profits of the business during this period.
MAC clauses are also often included in shareholders' agreements, joint venture agreements, loan documentation and project agreements among other commercial contracts.
Will MAC clauses be enlivened due to COVID-19?
Whether or not a purchaser or contract counterparty may validly invoke a material adverse change clause depends on the specific drafting of the relevant clause.
Given the scale of the impact of COVID-19 on businesses globally, it is likely (absent very specific carve-outs for events such as the COVID-19 pandemic) such provisions will be enlivened in the current climate.
While there may be a material difference between the macro-economic impacts of COVID-19 and short term impacts on your business, certainty as to whether MAC can be triggered will only be gained by reviewing the wording of the contract.
In a financing context, Australian financiers, in particular the big four banks, have rarely triggered a MAC clause as the sole provision in the event of default. The COVID-19 environment may lead banks to take a more aggressive interpretation as to whether the clause is triggered, but it is too early in the stage of the pandemic for banks to be able to assess the impact it will have on a borrower's financial or trading condition.
What are the consequences of invoking a MAC clause?
MAC provisions are increasingly being drafted to give parties the right to terminate a contract where the provision is enlivened rather than being drafted as conditions precedent. Ultimately, the practical outcome is the same. The transaction may not proceed and parties may cease the contractual relationship.
If a deposit has been paid, typically this would be returned to the purchaser but this also depends on the drafting of the transaction documents.
In the context of certain lending documentation, shareholders' agreements, joint venture arrangements and other commercial contracts, a material adverse change condition may be an event of default giving rise to various consequences or penalties affecting the defaulting party. These may be triggering draw stops and/or mandatory repayment in loan agreements or mandatory transfer of securities regimes (often at a discount to market value) or loss of voting rights in shareholders' agreements.
What should businesses be doing?
We recommend reviewing transaction documentation and relevant commercial contracts to confirm whether there are MAC clauses which you may invoke to benefit your business or which other parties may invoke against your business.
How can we assist?
We recognise that COVID-19 creates many challenges for companies. Our M&A, finance and litigation specialists are assisting many clients with practical advice as circumstances evolve.
If you would like further advice or assistance regarding COVID-19 and MAC clauses, please contact us.
