Material adverse effects clauses have come under the spotlight in a Commercial Court case that considered whether the defendants were entitled to withdraw from the purchase of a Brazilian nickel mine on the basis of a geotechnical event that affected the site between exchange and completion. The case has given valuable guidance on how courts should construe material adverse effect termination clauses in share purchase agreements, and emphasised the high threshold for establishing an entitlement to withdraw.
What are material adverse effect clauses?
Alongside indemnities, warranties and representations, material adverse change (MAC) or material adverse effect (MAE) clauses are one of a range of mechanisms commonly used to allocate risk in a share purchase agreement (SPA) where there is a split exchange and completion. They are also seen in a wide range of other commercial agreements. In the context of a SPA, they give the buyer protection against the possible incidence of certain adverse events that might fundamentally alter the bargain the parties have struck (based on the diligence exercise undertaken to that point) in between the date of (or otherwise specified in) the SPA, when the buyer is generally committed (subject to fulfilment of certain conditions) to the acquisition, and the agreed completion date. If an event occurring in that period has a material adverse effect on the target company, then the buyer may be entitled to terminate the SPA and walk away from the purchase.
Background to the claim
BM Brazil & Ors v Sibanye BM Brazil & Anor [2024] EWHC 2566 (Comm) concerned two SPAs for the acquisition of Brazilian mining assets. The main issue in dispute was whether the buyer was entitled to refuse to close under the contracts, and to terminate them, on the ground that a geotechnical event (in layman's terms, a landslip at the mine) that had occurred after signing the SPAs, but before completion, constituted a MAE. The sellers disputed that the event constituted a MAE and maintained that the buyer's termination, and attempt to avoid completion and payment of the purchase price agreed, was wrongful and repudiatory (such that it was entitled to recover damages flowing from the buyer's refusal to complete).
The courts' approach to interpreting MAE clauses
While Butcher J acknowledged that the court's task was to apply the ordinary principles of construction of contracts (as summarised in Wood v Capita), he also noted a relative dearth of previous English authority on the interpretation of MAE clauses, particularly in the specific context of SPAs. Like Cockerill J before him in Travelport Ltd v WEX Inc, he therefore also referred to the more established body of MAE cases that have developed in the US (in particular, Delaware), together with academic commentary. Applying those principles, the instructive judgment draws out a number of key points relevant to the interpretation of MAE clauses.
Material in whose eyes?
Drawing on the US decision, Decura, Butcher J held that it was necessary to come to an objective assessment of what 'would reasonably be expected to be material and adverse', rather than relying on the subjective views of the affected party. He clarified that this objective assessment involves the following:
- An evaluative judgment (by the courts) as to what was reasonably to be expected.
- This judgment should be made from the perspective of a reasonable person in the position of the parties at the time when cancellation on the basis of the alleged MAE was notified. As such, the courts should consider (and not ignore, despite the objective nature of the assessment) the parties' contemporaneous assessment of the position, in order to shed light on what it was reasonable to expect, rather than assessing what was reasonable in hindsight.
- Butcher J considered the degree of likelihood for the assessment to be "whether a reasonable person would have considered it more likely than not that the matter would turn out to be material".
High threshold for materiality
From the body of existing case law, Butcher J concluded first that there is a high threshold to establish that an adverse effect is 'material' in the context of a party seeking to withdraw from the acquisition of a company as a result. In this context, it does not simply mean 'more than de minimis' - it must be significant or substantial, because it is being relied upon to discharge a contract for the long-term acquisition of a target company. However, there is no bright line test for materiality that will apply to all MAE clauses and, as the judge acknowledged (citing various different metrics from various different cases), it is a context-specific issue and one in which a number of factors may be relevant in determining what is material in any given case.
Quantity over quality
One of the defendants' submissions was that an adverse effect could be material even if it could not be measured in financial terms. This argument did not find favour with the judge though, who said "if there is no significant quantitative impact, then it is difficult to see that such 'qualitative' matters could, on their own, mean that the 'change, event or effect' was 'material and adverse".
When it came to assessing the level of financial impact that would satisfy the materiality threshold, Butcher J considered the judgment of US judge Laster VC in Akorn Inc v Fresenius Kabi AG, which states that a "drop in value of more than 20% would be material to a reasonable strategic acquirer". Butcher J went further in this case though, saying that a "lesser reduction might also be material. I tend to think that a reduction of more than 15% might well be material". In his view though, "a 10% reduction in the value of the company" (which was held to be material in the Finsbury Foods case in a different context) was "rather too low to count as material for the purposes of the MAE provisions here". It should also be noted that the judge's ultimate conclusion in this case was that, whether materiality had been 10%, 15% or 20%, on the facts of the claim none of those thresholds were met.
Duration of adverse effect - years rather than months
In the context of SPA termination provisions, the judge also considered that, for an effect on the target to be considered 'material', there should be proof of significant long-term financial detriment, not just short-term fluctuations. Referring to the US authority Re IBP Inc. Shareholders Litigation, Butcher J approved the sentiment that a buyer needs to show the company has suffered "a material adverse effect in its business or results of operations that is consequential to the company's earnings power over a commercially reasonable period, which one would think would be measured in years rather than months".
Ultimately in this case, after hearing expert evidence on the geotechnical event and its impact for operation of the mine, the court held that while the adverse event did have a financial impact in the millions of dollars, the financial impact was not sufficient in the context of this transaction (amounting to, on any assessment, significantly less than 10% of the purchase price) to be "material". The adverse event did not, therefore, constitute a MAE and consequently the buyers had not been entitled to withdraw from the transaction.
Buyer beware - a high bar for termination
This judgment provides a useful guide to the principles, in large part imported from US case law, that courts in England and Wales will apply in assessing MAE clauses. Although in this case the court recognised that MAEs are part of the contractual toolbox for allocating the risk of adverse post-signing events, the judgment makes clear that there is a high bar for buyers seeking to rely on them to withdraw from a transaction. As a result, buyers should also ensure that adequate diligence is completed and supported by other risk allocation tools in a SPA, including warranties and indemnities.
While this case turns on a SPA, which is likely to raise the bar for termination even higher, the key principles are also likely to apply to similar forms of MAE used in other commercial agreements.
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