Practical guidance for the drafting and invoking of MAC clauses

The English Commercial Court has recently handed down an important decision, which is likely to become the leading authority on how to interpret MAC clauses in mergers and acquisition agreements and loan and other agreements. In this case which involved a mining company, the Court has considered the factors that should be taken into account when invoking a MAC clause generally, as well as specific factors to be taken into account in the Energy, Natural Resources and Infrastructure sector.

The key points which the English Courts will consider when approaching MAC Clauses include:

MAC clause essentials

• Purpose: MAC clauses distribute the risk of significant changes or disruptions affecting the target business from the time of signing to closing.

• Litigation: Cases from the US (and especially Delaware) are looked to for guidance on MAC clause interpretation in England and Wales as the clauses rarely appear before the courts here. Sibanye, however, draws several key distinctions in approach, outlined below.

• Consequences: Incorrectly invoking a MAC clause will result in severe repercussions for the purchaser.

When negotiating and drafting a MAC clause:

1. Determine the appropriate allocation of risk

• Though broader clauses may appear to advantage a purchaser, they will be read in the context of the entire agreement including other risk allocation provisions such as the representations and warranties and should be drafted to reflect the specific circumstances of the deal [231].

• Detailed carve-outs may be used to protect a seller by preventing events outside of their control giving rise to a termination right. Events that occur as a result of performance of the contract may be excluded from constituting a MAC, but this will not automatically extend to events arising from normal operation of the target's business [309].   

The Courts will look at the parties' objective in the MAC Clause.  In Sibanye, the MAC definition and its use within the MAC condition demonstrated that it was concerned with matters occurring after signing. Where a consequence of the "change, event or effect" and the investigations it triggered relate to problems in existence when the SPAs were signed, these are irrelevant.

2. Consider whether to permit aggregation of changes, events, and effects

• Permitting changes, events, and effects to be considered in aggregate will broaden the factors that can contribute to the materiality threshold [232]. This might make it easier to invoke the MAC clause at a later stage.

3. Define materiality clearly and precisely

• Broad drafting (requiring that there is a material adverse effect on "the business or financial condition or ...") is not necessary - it is enough to just require an effect on "the company" and this is how courts in England and Wales and the US will interpret the clause in any event [221].

• The starting assumption in both English and US courts is that MAC clauses will only encompass long-term impacts and events [249]. Purchasers who are concerned by this may wish to specify a shorter timeframe within the clause that explicitly captures short-term dips in the financial health of the target.

• Material requires something "significant or substantial". The metrics used to determine materiality should be set out as clearly as possible (e.g. in the form of a percentage threshold or similar). Without this, the Court is likely to impose its own minimum, which varies on a case-by-case basis looking at the size, nature of the assets, length of the process and complexity [253]- specifying a value will therefore reduce uncertainty for both parties.

Before invoking a MAC clause, ask:

1. What is the nature of the change, event, or effect?

• If the change, event, or effect is qualitative only, this will not be sufficient grounds to invoke the MAC clause in English courts (though qualitative effects may be considered when litigating in the US) [222; 259].

• If the change, event, or effect is 'revelatory' (i.e. reveals a preexisting issue not previously known to the party), this is not covered by the MAC clause [232].

• Use of phrases such as "would reasonably be expected to be material and adverse" require an objective evaluation and judgement, rather than considering a range of possible views. The degree of likelihood implied by such wording was "more likely than not", making a mere risk of materiality insufficient [245].

2. Is it reasonable to expect a material adverse effect in the circumstances?

• This is assessed objectively at the point of termination of the agreement in both US and English courts [225; 244]. Purchasers therefore face a 'use it or lose it' right to terminate the agreement.

• Any actual assessment made at the time of termination might go towards reasonableness, but only if made on an objective basis [284].

• It is possible to rely on evidence that was presented to the parties at the time of termination, but this must be taken as a whole and assessed objectively [274]. Evidence produced later will not be used to decide whether a decision to terminate was reasonable [282].

• Any justifications relied upon should be based on sensible and defensible assumptions [301].

• Once a material adverse effect is expected, it is important to act in good faith to ensure that any steps taken to investigate are considered reliable. This might include making enquiries of the seller and giving them a reasonable opportunity to address or comment on the issues [287].

3. Is it possible to demonstrate sufficient materiality?

• The purchaser must demonstrate the event, change, or effect is sufficiently material in both the US and English courts. The threshold for this is higher in the US due to a 'special rule' regarding the narrow interpretation and heavier burden on the party seeking to invoke the clause. This is not the case in England and Wales [227].

• A purchaser must consider the specific characteristics of the underlying asset and the transaction's scale and complexity when deciding if an event is material [251].

• A change/event resulting in a 15-20% reduction in the underlying value of the target business is likely to be regarded as 'material' in England and Wales (with a similar approach in the US) [252-255]. A 10% reduction is likely too low for the English Courts but this will depend on a number of factors. The impact of any change/event on the target business should be evaluated against the backdrop of the purchaser's acquisition strategy. For example, for acquisitions aimed at long-term strategy integration, 'materiality' should be measured "in years rather than months" [249].

4. What factors do the courts take into account when assessing materiality in the context of Geotechnical events?

• How often incidents occur in mines generally and at that mine;

• The nature of the event;

• The scale of the event in the context of that mine and the industry as a whole;

• Whether there was any loss of life or injury;

• Whether equipment was lost;

• The duration of the event;

• When operations resumed;

• Whether the event had any adverse regulatory consequences;

• Whether there was a loss of ore or to any extension of the life of the mine;

• Financial impact of any delay in mining ore; and

• Financial impact of mining additional waste.

MAC/MAE clauses in loan documents 

In Sibanye, the judge observed that there are important differences in how MAE/MAC clauses are interpreted and applied in loan agreements compared to M&A documents  due to their distinct objectives and the nature of the agreements. In the context of facility agreements, MAE clauses are primarily concerned with the borrower's ability to repay the loan.  MAE often appears as a defined term, which is used to qualify undertakings, representations and events of default appearing elsewhere in the document. An MAE in the financial position of the borrower also usually appears as a separate event of default.  

When such a clause is invoked by a lender, the court will conduct a similar, though not identical, exercise as it would in a merger or acquisition scenario. The primary goal for the lender is to show that an adverse change has occurred by reference to the financial condition of the borrower at the relevant time. The interpretation therefore tends to be narrower than for M&A transactions, focusing on the financial health and performance of the borrower. These clauses are often specifically defined in terms of financial metrics and thresholds and trigger events typically relate to financial covenants, such as breaches of financial ratios or defaults on payments. Evidence other than financial information may be considered, but only where this is relevant/persuasive. The change in the borrower's circumstances will be considered 'material' if it substantially impacts the borrower's loan repayment capabilities. This differs from the M&A position, where a broader perspective is taken on materiality that encompasses a wider range of factors affecting the target company's value or operations.

In loan agreements, enforcement of MAE clauses can lead to acceleration of the loan, demands for immediate repayment, or adjustments to the terms of the loan.  In M&A, an MAE/MAC clause can provide a basis for renegotiation of the purchase price, or in some cases, a right for the buyer to walk away from the deal.

Other contracts

Whilst not addressed in Sibanye, it should be noted that MAE/MAC clauses are also used in other types of agreements, for example, underwriting agreements where both business and market MAC clauses are common. In these types of agreement, other considerations may also come into play but the purpose of the MAC clause, which is both to qualify the certain conditions and warranties and to give rise to a termination event, will be an important in their interpretation.

If you would like to discuss the case further or have any questions regarding MAE/MAC clauses, please contact your usual Simmons contact or:
Alexander Keepin, Corporate
Iain Duncan or Joanne Elson, ENRI
Rob Turner or Victor Croci, Dispute Resolution