In a merger and acquisition agreement (M&A) there is a relatively minor clause, but with dramatic consequences. The MAC clause (Material Adverse Change) is a clause intended to settle the risks between the parties that may emerge in relation to the acquired corporation and/or the assets purchased between the signing date and the closing date. Thus, the parties must reach an agreement regarding the nature of the changes that may occur in the aforementioned schedule, which may influence the transaction's price, in order to determine who among the parties will bear the aforementioned risks, which may, in extreme scenarios, lead to the termination of the transaction by the purchaser.
MAC – Overview
Generally, in complex transactions, and specifically in an M&A, there is a time gap between the signing date and the closing date. During the aforementioned period, the parties must carry out various actions to complete the transaction, as well as wait for the receipt of permits from government authorities such as the Tax Authorities, the Securities Authority, the Antitrust Authority, etc.
Consequently, the price of the transaction determined at the signing of the transaction and based on commercial and financial data that were valid and relevant at that time, may differ for various reasons: internal reasons and processes within the acquired company, the performance metrics of the acquired company, updating of declarations and representations due to legal procedures, regulatory permits, etc. Thus, the MAC clause defines irregular circumstances in which the condition of the purchased asset dramatically deteriorates due to various circumstances, in a manner that justifies the termination of the transaction by the purchaser.
In most agreements, the definers of the MAC clauses exclude events that are out of the company's control, such as: downturns in the financial markets, adverse change in the global security situation (mass terror attacks), non-fulfillment of analysts' forecasts, etc.
It must be mentioned that the legal discussion upon examination of the MAC clause must start with a combined and cumulative analysis of the mechanism's three components: (1) change, (2) significant and (3) adverse. Meaning, the purchasing party that wants to terminate the transaction, must prove that it is a significant event that did not exist prior the signing of the transaction, and that it is not a minor event but rather an event with significant influence on the business of the acquired company.
The Rulings of the American Courts
Needless to say, most verdicts in the context of the MAC clauses were obtained abroad, with emphasis on American ruling. For many years, and probably to this day, the common approach has been to minimize such clauses and stick to the principle of 'buyer beware' in complex transactions, and insofar as there is a significant concern of the buyer regarding events that may occur after the date of signing, said concern should be handled by other clauses in the purchase agreement, and maybe even handled in the mechanism of the price per share.
Lately, the Supreme Court of Delaware ruled in the case of Akorn Inc. Vs. Fresenius Kabi AG that the purchaser in a merging transaction should be permitted to terminate the agreement due to significantly adverse changes in the businesses of the acquired company.
To summarize, the German pharmaceutical company Fresenius wished to terminate their agreement concerning the purchase of the American pharmaceutical company Akorn, due to significant adverse changes in the monetary results of Akorn during the period prior to the completion of the transaction, and also due to the fact that Fresenius pointed out inaccuracies in representations provided by Akorn within the framework of the transaction and its failure to meet the FDA's regulation standards.
The Supreme Court accepted in a brief opinion the long and reasoned ruling (246 pages) of the lower court that determined that Akorn's shortcomings in the regulatory field could not be amended prior to the completion of the transaction, and would have led to a MAC also in the business of the acquiring (the merging) corporation. The court also examined other companies that dealt with similar problems and found that Akorn is one of the only companies that dramatically failed in the way it dealt with these problems, and insofar as the extensive legal analysis lead to the conclusion that Fresenius was entitled, and justifiably so, to terminate the transaction due to the dramatic change that applied to Akorn's businesses prior to the completion of the transaction.
It must be mentioned that the Akorn affair does not necessarily constitute a significant and dramatic change in the courts' stand regarding the MAC clauses, since in this matter, it was proven to the court that there was lack of good faith on behalf of Akorn in the statements and representations that were provided in the framework of the purchase transaction, as was mentioned also in anonymous letters that were sent to Feresnius by Akorn's workers.
The Israeli Law – the Contract Prevention Doctrine in the Contracts Law
The Contract Prevention Doctrine appears in clause 18 of the Contracts Law (Remedies for Breach of Contract) of 1970 (hereinafter: "The Contracts Law – Remedies") and represents a mechanism that is stricter than the American law. First of all, the mechanism stipulated by law is significantly different from the determination of a contractual mechanism that is more flexible and can be adjusted to the specific negotiation between the parties of the transaction. Second, the Israeli courts have also traditionally minimized and almost emptied the instructions of clause 18(a) out of content, while ruling that even a state of war is the result of circumstances that the parties should have anticipated1.
As to our matter, the discussion on the Israeli law should be held, among other things, in light of additional stipulations of the law that accompany commercial transactions, with emphasis on the stipulations of clause 12 of the Contracts Law (Obligation of Good Faith in Negotiations) and clause 39 of the Contracts Law (Obligation of the parties to fulfill the contract in good faith after its signing). Thus, in a situation where a party to the contract can show that the other party concealed significant details about the transaction or the purchased asset, it would have a better chance trying to terminate the agreement than relying on the Prevention Doctrine.
To our estimate, the obvious conclusion from this summarized discussion about the effectiveness of the MAC clause is that a purchaser cannot rely on the stipulations of the law and hope that he might be released from an acquirement or merging transaction. Despite the recent ruling in the American law (and definitely in light of the old ruling in the Israeli law regarding the Prevention Doctrine), the court's clear tendency is still to significantly minimize the possibility of the purchaser to terminate a transaction in light of the changes in the condition of the acquired asset, even if the changes are significant and occurred following the date of the signing and prior to the completion of the transaction.
The trivial but obvious recommendation is to make sure to add to the agreement other mechanisms of price updates, according to both time and business factors, thereby providing the purchaser some compensation in the event of irregular events that could not have been anticipated in advance.
1 C.A. 6328/97 Regev vs. the Ministry of Defense
Originally Published March 2019
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.