As the world faces a bear market for the first time in over a decade as a result of the spread of COVID-19 (or the Coronavirus), many M&A professionals are in limbo as they consider the rapidly-evolving risks to their current and future transactions.
For agreements that parties have signed but not closed, the question is arising whether the global coronavirus pandemic could allow a reluctant buyer to invoke an agreement’s Material Adverse Effect or Material Adverse Change clause (collectively, an “MAE” clause), which could allow the buyer to walk away from the transaction. Indeed, regardless of whether such an invocation would hold up in court, nervous buyers may be inclined to assert that an MAE has occurred in order to gain leverage to renegotiate the terms of the purchase agreement. Conversely, sellers may be looking for guidance on their rights to force buyers to close on pre-agreed terms.
Importantly, the applicability of an MAE clause is highly fact-specific and depends on the language of the MAE clause itself, the governing law of the agreement and the facts and circumstances regarding the impact of the coronavirus on the target company. In general, specifically tailored language is easier to enforce than general language. The following are just a few factors that may influence whether the COVID-19 pandemic could allow a party to invoke an agreement’s MAE clause:
- Magnitude of the economic effect. In the leading Delaware case interpreting MAE applicability, the Delaware Chancery court addressed the magnitude of the effect that would be necessary to trigger an MAE clause. Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018), aff’d, No. 535 (Del. Dec. 7, 2018). The inquiry into the magnitude of the effect is highly fact-specific. In general, the effect must “substantially threaten” the overall earnings potential of the target. Id.
- Duration of the outbreak. One of the uncertainties surrounding the COVID-19 outbreak is how long it will continue to affect the global economy. However, to successfully invoke an MAE clause, a party must meet a high burden demonstrating an event that would “substantially threaten the overall earnings potential of the target in a durationally-significant manner,” which should be measured in “years rather than months.” See id. As a result, up to date information about the severity and likely impact of the pandemic going forward will likely be relevant to the inquiry.
- Disproportionate impact on the target company. The typical MAE clause “allocates general market or industry risk to the buyer, and company-specific risks to the seller.” Id. As a result, a general market downturn may not be sufficient to successfully invoke an MAE clause. Further, courts may reject the invocation of an MAE clause even if a target is in a specific industry that is disproportionately affected by the outbreak as compared with the general market because courts often look to whether the impact is company-specific, not industry specific. So, if other companies in the industry are similarly affected, parties may be stuck with the transaction they bargained for. As a result, a court would likely assess whether the outbreak has had an acute impact on the target company.
It is important to note that MAE clauses are often specifically negotiated and can vary widely between transactions. For example, such clauses may contain particularized definitions or exclusions that would have to be interpreted in light of the facts at hand. If you have a question about the potential applicability of a particular MAE clause, please contact the authors.
The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP. Specific legal advice depends on the facts of each situation and may vary from situation to situation. Information contained in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.