Impact of COVID-19 on Mergers & Acquisitions with Special Reference to the MAC Clause
Written by Hardik Dave
Fifth Year, BBA. LLB. Symbiosis Law School, Pune
Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.
The Novel Coronavirus (“COVID”) over the past few months has affected the lives of both persons and artificial judicial persons. It has sent a spine-chilling wave of economic setback across the globe, setting an unprecedented example for businesses all around the world. The virus continues to permeate our society and financial markets strive to maintain stability. It has disrupted supply chains, leading to the shutting down of numerous manufacturing facilities globally, hindrance of air and sea traffic causing the closure of significant air routes. All these factors have made it difficult for companies to maintain liquidity, keep up the operations and survive the pandemic. COVID has had a major impact on deal-making as the valuation of the companies has taken a blow and the stock markets have experienced the steepest fall seen in recent times in a relatively brief period of time. Ergo, every business transaction remains uncertain until the air clears.
The pandemic has led to several deals being called off. Xerox dropped its $35 billion offer for HP citing “coping with the pandemic”. Softbank has terminated its $3 billion tender offer for WeWork shares stating the failure of a number of closing conditions. Boeing suppliers Hexcel and Woodward have also called off their pending $6.4 billion merger of equals transaction noting “unprecedented challenges”.
MAC Clause – Meaning
M&A transactions that have been initiated and are in their nascent or pre-closing state will have to survive this adversity. One of the major aspects that the transacting party is turning towards is whether COVID triggers the concept of Material Adverse Change (“MAC”) clause.
It has been noted that the interpretation of a MAC clause is dealt with on a case-to-case basis by courts and such interpretation mainly depends on the manner in which the clause has been drafted in the contract coupled with the law governing such contract.
Generally, the MAC clause in case of an acquisition agreement contemplates events which, if they occur or are likely to occur, would have a “materially adverse change or effect on the assets, business, property, liabilities, financial condition, results, operations of the target” or that “affects the ability of the transacting parties to consummate the transaction” or the “validity or enforceability of the transacting parties to its rights and remedies under the transaction documents”. Essentially, a MAC clause comes into play when an unforeseen event alters the position of the target’s business, its continued existence or the enforceability of documents. From the seller’s perspective, it is essentially a representation or warranty given in relation to the state of their affairs.
It has been observed that while the acquirer might want to keep the scope of the MAC clause as wide as possible, the seller will try to limit it to certain events such as “changes in market, economic, legal, financial or political conditions”. The acquirer may want to include a condition of general change that covers a “disproportionate effect on the target company, its assets or operations” which may allow the acquirer to take the backdoor exit from the deal.
In certain cases, where the deal is more acquirer friendly, the clause may include various events such as national/international political and social conditions, banking or securities markets, changes in applicable laws, the legality, validity or enforceability of the rights or remedies of the investors, etc. On the contrary, in seller friendly deals, provisions have been drafted to exclude natural calamities such as floods, earthquakes and even pandemics.
When can a MAC Clause be invoked?
A MAC clause may be invoked at any time between the signing of a letter of intent and before the closing of the deal. In the absence of judicial precedents on the issue at hand, a parallel may be drawn with the invocation of the force majeure clause. A force majeure event is reported or invoked immediately by giving a notification as soon as the party becomes aware of the existence of any impossibility, occurrence or event. The acquirer should be alert and should invoke the clause within a reasonable time by issuing a notice of dispute calling out such an event that it might be aware of. If the notice of completion of conditions precedent is not disputed within a reasonable time, the acquirer may become liable to close the deal.
Interpretation of MAC by US and UK Courts
Specific cases related to an M&A transaction have come before the courts of law in the United States. In a landmark case, In re IBP Inc. v. Tyson Foods Inc. (“IBP Inc.”) the court held that the entire burden of proof of a material adverse effect is on the claimant. Merger contracts cover a large number of warranties, representations and conditions precedent citing risks of the parties explicitly. Therefore, even in cases where the MAC clause is broadly worded, a “short-term hiccup” does not satisfy the condition of a material adversity and hence a much “durationally-significant” impact is necessary to show such adversity. In another case, Frontier Oil v. Holly Corp, the court relied on the IBP Inc. judgment to apply the same test of an adverse event being material and durationally-significant.
In another US case, a merger agreement was entered into between two companies. Several representations were made by the claimant company about its compliance with the regulatory requirements and commercially reasonable efforts to operate in the ordinary course of business. However, the defendant failed to maintain such a commercial standing. The court held that the position of the claimant before entering into such a merger agreement as opposed to the position at the time of filing the case was materially different. The magnitude of the inaccuracies led to a material adverse effect. Hence, the defendant’s action of terminating the merger agreement citing the MAC clause was upheld.
There have been very few cases on the issue of the MAC clause in the United Kingdom as such a clause is barely invoked by parties to a transaction. In one of the landmark cases on MAC clauses adjudicated by the UK Commercial Court, one of the companies, a party to the transaction, was held to be justified in withholding further funds under a loan agreement entered into with the other party. In this case, the defendants had argued that there was a “Materially Adverse Change” in the position of the guarantor of the appellant from 2007 to 2008 but no representations were made in that regard. Hence, despite the order of the court being in the favour of the defendants, no case as to MAC was proved against the appellants.
A similar judgment was delivered placing reliance on this case. Both these cases laid down some interpretations with respect to a MAC clause:
(a) The interpretation of MAC is strict and limited to the language of the contract.
(b) The most significant of all the conditions is that the event/circumstance should be material. It must change the position of the other party significantly and the effect must not be temporary.
(c) The burden of proof of a materially adverse effect is on the party claiming such a clause.
(d) No party can invoke MAC on the basis of issues of which it was aware of before entering into the contract. This however does not bar the party to invoke the MAC clause if the condition existed but worsened making it a “material” change.
Interpretation by Indian Courts
In India, the issue of withdrawal from a merger or an acquisition by the invocation of the MAC clause has not been brought up as a defence in before any court of law. However, interpretation on the basis of judgments on the issue of impossibility of performance and interpretation of the same with respect to a merger or acquisition can be taken as a yardstick.
The Supreme Court in the case of Nirma Industries Ltd. and Ors. v. SEBI delved into the meaning and interpretation of the term ejusdem generis (of the same kind) on clauses b, c and d of regulation 27(1) of the SEBI (SAST) Regulations. The Apex Court stated that the common thread that runs through the three sub-clauses is the impossibility in carrying out a public offer. SEBI has the discretion to decide on the impossibility under clause (d). The Hon’ble Supreme Court held that the fact that the target company had perpetrated fraudulent transactions resulting in embezzlement of funds in excess of Rs. 350 crore after the public announcement of acquisition of 24.5% of the equity shares of the target did not result in the impossibility of performance by the acquirer.
It has been observed that the courts in US and UK have taken a strict interpretation of the MAC clause and generally have not allowed the acquirer to withdraw from a transaction on the basis of a “material adversity”. In several cases where there has been a delay by the adjudicating authorities or any pending case or an unusual delay due to misrepresentation or misstatement in the open offer, the courts have not construed it to be a material adversity.
In the absence of precedents on this issue, another way in which an acquirer may withdraw from a contract is by invoking Sections 32 or 56 of the Indian Contract Act, 1872. The entire purpose of a MAC clause is to allow the acquirer to escape the obligation of performance when any event that affects it renders it incapable of performing such an obligation.
Whether COVID can be treated as a material event
It is abundantly clear from the aforementioned analysis of the precedents of various jurisdictions that the interpretation of what constitutes a ‘material event’ will differ from case to case. Several factors such as the language of the clause, the severity or the durational impact of the event, impact on the industry in general and business in specific, etc. Some industries have suffered a direct impact whereas some industries saw growth due to the need for essentials. Hospitality and travel industry among other small, micro and medium industries including all the other offices un-equipped with the provision of work from home facility have taken a hit. On the other hand, industries dealing in food, consumer goods, essential supplies such as sanitization material have seen a boom due to increased demand.
If the wording of the MAC clause excludes natural disasters including epidemics and pandemics it will be difficult to resort to the clause. Similarly, a broadly worded MAC clause if invoked will have to be proved sufficiently. The invocation of the clause puts a heavy burden on the party invoking it and it will have to prove that COVID has materially affected its capability to close the deal.
Options available to the parties
The COVID event has taken everyone by surprise. There is no doubt that businesses have been affected devastatingly, some have been rendered out of business and some are on the verge of shutting down. In this trying time, it is important for the parties to have mutual respect and acknowledge the loss caused at both ends. The parties may defer such transactions to a further date allowing them to recover from such losses and stand on their feet.
COVID has only made businesses more aware and alert of uncertainties of this sort.
The companies that enter into any transaction from this event forward will have specific force majeure and MAC clauses.
The acquirers may ask for additional warranties, the requirement of completion of conditions precedent, and the option of withdrawing from a transaction in case of inadvertent delay caused due to the seller’s actions or such other relevant clauses.
What will change?
After being exposed to such a potential harm to the businesses, building immunity against such harm will help industries accelerate out of the downturn. In terms of M&A transactions, while a lot of parties may slow down on their dealings, some may view it as an opportunity to either cover a wider market by way of acquisition or collaborate resources to rise up from a low point.
A lot of things with respect to an M&A transaction will change. The drafting of several clauses will become more specific, the parties will try to gauge the damage caused to the financials due to COVID both to the acquirer as well as the target. The famous “getting everyone in the room” phrase will lose relevance and preference will be given to digital and online mediums for negotiations.
One of the most drastic changes that will be observed will be in the manner in which due diligence will be conducted. For companies equipped with sufficient tools, due diligence and meetings will continue with the help of virtual data rooms and video conferencing. The acquirer will now extend its diligence to the seller’s insurance policies, especially business interruption policies, health and disability coverage for employees, crisis management procedures, exposure of the business to COVID, data security and privacy while dealing with data rooms and utilising work from home tools, implementation of health and safety standards for employees coming to the workplace, etc.
Both parties will have to maintain care and caution before entering into the terms of a merger or acquisition. There is an increased burden of disclosure on the parties. Initially, till the online methods of dealing take shape, the process might be slow and the negotiations may also be affected due to technical reasons. Lastly, the process of obtaining regulatory approvals will also slow down as effective functioning of the courts has not begun yet, due to COVID. The parties will have to communicate the impact of such an inordinate delay and assess the foreseeable impact of the same.
The current pandemic has affected lives both financially as well as mentally. People have turned towards their only option for fairness and justice, the courts. There have been ample cases filed by parties to contracts, be it tenancy agreements, loan agreements or any other type of agreement. It is the opinion of the author that the court should keep in mind the interest of both the parties, consider the scenario which we are in and decide the matters accordingly. A narrow interpretation of the clauses in the agreements will cause hardship to the already suffering parties. Some sort of leniency allowing the parties to reach a reasonable solution, either by giving time to mutually settle misunderstandings or by resorting to alternative dispute resolution methods to amicably decide on a solution beneficial to both will go a long way and ultimately serve a larger purpose.
A change in perspective and bringing in a ‘new normal’ into the transactions will become a necessity. With the increased expenses and drastically reduced incomes, survival has essentially become a litmus test of sustainability for companies. With the changes in the deal-making scenarios, the government is also attempting to facilitate the growth of local businesses. A wave of entrepreneurship has run across the nation. Though financial stability remains a blur, the adaptation to the ‘new normal’ and using it to our own benefit gives a ray of hope that we can march towards. Experiencing the most ignored clause come to light and become the thread on which a deal hangs displays the importance of a well drafted contract.
 Greg Roumeliotis, ‘Xerox abandons $35 billion hostile bid for HP’, (April 1, 2020); https://www.reuters.com/article/us-hp-m-a-xerox-hlngs/xerox-abandons-35-billion-hostile-bid-for-hp-sources-idUSKBN21I3C0  Sam Nussey, Kanishka Singh, ‘WeWork troubles deepen as Softbank pulls $3 billion tender offer’, (April 2, 2020); https://www.reuters.com/article/us-softbank-group-wework/wework-troubles-deepen-as-softbank-pulls-3-billion-tender-offer-idUSKBN21K052  James Fontanella-Khan and Claire Bushey, ‘Boeing suppliers Hexcel and Woodward call off $6.4bn merger’ (April 6, 2020); https://www.ft.com/content/3b5fa7d4-2456-4950-9265-3e12a67354a6  Supratim Guha, Poonam Pal Sharma, Parag Srivastava & Simone Reis ‘Can COVID-19 amount to a material adverse change?’ (April 01, 2020); http://www.nishithdesai.com/information/news-storage/news-details/article/can-covid-19-amount-to-a-material-adverse-change.html  In re IBP Inc. v. Tyson Foods Inc. 789 A.2d 14 (Del. Ch. 2001).  Frontier Oil v. Holly Corp., 2005 WL 1039027.  Mrs. Fields Brand, Inc. v. Interbake Foods LLC, C.A. No. 12201-CB (Del. Ch. Jun. 26, 2017).  Arkon Inc. v. Frensenius Kabi AG, C.A. No. 2018-0300-JTL.  Grupo Hotelero Urvasco and Grupo Urvasco v. Carey Value Added Ltd. & Ors.  EWHC 1039 (Comm).  Decura IM Investments LLP & Ors. v. UBS AG, London Branch  EWHC 171 (Comm).  Nirma Industries Ltd. and Ors. v. Securities and Exchange Board of India (09.05.2013 - SC); AIR 2013 SC 2360, MANU/SC/0536/2013.  Regulation 27(1), SEBI (Substantial Acquisition of shares and takeovers) Regulations, 1997.  Section 32, Indian Contract Act, 1872.  Section 56, Indian Contract Act, 1872. Bibliography
1. Regulation 27(1), SEBI (Substantial Acquisition of shares and takeovers) Regulations, 1997.
2. Section 32, Indian Contract Act, 1872.
3. Section 56, Indian Contract Act, 1872.
1. In re IBP Inc. v. Tyson Foods Inc. 789 A.2d 14 (Del. Ch. 2001).
2. Frontier Oil v. Holly Corp., 2005 WL 1039027.
3. Mrs. Fields Brand, Inc. v. Interbake Foods LLC, C.A. No. 12201-CB (Del. Ch. Jun. 26, 2017).
4. Arkon Inc. v. Frensenius Kabi AG, C.A. No. 2018-0300-JTL.
5. Grupo Hotelero Urvasco and Grupo Urvasco v. Carey Value Added Ltd. & Ors.  EWHC 1039 (Comm).
6. Decura IM Investments LLP & Ors. v. UBS AG, London Branch  EWHC 171 (Comm).
7. Nirma Industries Ltd. and Ors. v. Securities and Exchange Board of India (09.05.2013 - SC); AIR 2013 SC 2360, MANU/SC/0536/2013.
1. Greg Roumeliotis, ‘Xerox abandons $35 billion hostile bid for HP’, (April 1, 2020); https://www.reuters.com/article/us-hp-m-a-xerox-hlngs/xerox-abandons-35-billion-hostile-bid-for-hp-sources-idUSKBN21I3C0
2. Sam Nussey, Kanishka Singh, ‘WeWork troubles deepen as Softbank pulls $3 billion tender offer’, (April 2, 2020); https://www.reuters.com/article/us-softbank-group-wework/wework-troubles-deepen-as-softbank-pulls-3-billion-tender-offeridUSKBN21K052
3. James Fontanella-Khan and Claire Bushey, ‘Boeing suppliers Hexcel and Woodward call off $6.4bn merger’ (April 6, 2020); https://www.ft.com/content/3b5fa7d4-2456-4950-9265-3e12a67354a6
4. Supratim Guha, Poonam Pal Sharma, Parag Srivastava & Simone Reis ‘Can COVID-19 amount to a material adverse change?’ (April 01, 2020); http://www.nishithdesai.com/information/news-storage/news-details/article/can-covid-19-amount-to-a-material-adverse-change.html