MAC clauses in M&A agreements

In the current economic, political and social situation, material adverse change clauses may help counterparties to preserve contractual certainty of transactions as complex as those regarding company acquisitions.

In the interim period between signing and closing of a transaction, the contractual conditions that the parties have agreed may be affected by unforeseen circumstances materially detrimental to the target company. This brings about the need to decide if the buyer is still obliged to close the deal and pay the agreed purchase price or, on the contrary, if it is legitimated to withdraw from the agreement –or, more frequently, renegotiate the terms of the transaction– without any liability for contractual breach.

The contractual allocation of the pre-closing risk between the parties is a key issue in this type of particularly complex agreements, given that the target business’ own dynamics, as well as that of the market in which it operates, could give rise to changes that may impact the economic and legal aim of the parties when executing the agreement. This need of the parties to protect themselves against unforeseen circumstances during the interim period is even more relevant in situations of great economic, political and social insecurity and uncertainty.

Traditionally, the Spanish Courts have applied very restrictively the “rebus sic stantibus” rule, which enables the debtor to exonerate or mitigate the negative impact of an unforeseeable and extraordinary contractual risk that has not been allocated among the parties at the time of the execution of the agreement. Furthermore, the Spanish Courts have also very restrictively applied other alternative jurisprudential rules (i.e. the rule of presupposition or implied condition, the rule of absence of the bargain conditions and the rule of frustration of contract) that pursue the same objective as the “rebus sic stantibus” rule.

In M&A deals, the shortage of judicial decisions considering and admitting the application of the “rebus sic stantibus” jurisprudential rule has motivated legal counsels to use clauses that, softening some of the grounds for application of the jurisprudential rules referred above, enable the parties to reallocate their contractual rights and obligations and regulate the consequences of unforeseen adverse events with direct impact on the target company.

It is the case of the MAC clause (-“Material Adverse Change“- or MAE -“Material Adverse Effects“-), which releases the buyer from its obligation to close the transaction upon the occurrence of material events that adversely affect the target company during the interim period.

MAC clauses are common in Spanish contractual practice (MAC clauses are present in 40% of share sale and purchase agreements (“SPA“) executed in our country), in particular in comparison with the other European countries. However, the greatest exponents in this field are the USA and the United Kingdom, where almost all of the merger and acquisition agreements include these clauses, which have been exhaustively analysed by legal scholars and case law.

Under Spanish Law, MAC clauses are atypical and of dispositive character. Thus, if the parties decide to include them in the SPA, they can draft them as they want, with respect only to the principle of free will general limitations.

MAC clauses are complex and need to be drafted very precisely. Failure to correctly draft a MAC clause may result in its ineffectiveness and also in future disputes between the parties. Some of the essential aspects of MAC clauses that the parties and their counsels should ensure to cover and properly structure in the SPA are, among others: detail the events that constitute a material adverse change and those that are carved out from the definition (some examples of events which are not intended to qualify as a MAC are, among others: acts of terrorism, natural disasters and relevant changes in the political conditions of a country or in its current legislation); define the materiality standard; and specify the effects of the MAC clause (basically, the buyer’s right to terminate the SPA without any penalty or, most commonly, an adjustment of the purchase price to be paid as from closing).

MAC provisions may be used in different parts of the SPA, either alternatively or cumulatively. Usually, they are drafted in the representations and warranties granted by the seller, where the seller makes a representation which favours the buyer regarding the non-occurrence of a material adverse change since a given date or within the period of time elapsed between the reference financial statements and the closing date. In this case, the buyer would not be entitled to refuse to close the transaction, but to claim for damages. MAC provisions can also be drafted as closing conditions or as subsequent conditions. In both cases, the buyer would be entitled to withdraw from the transaction upon the occurrence of a material adverse change, without any liability for contractual breach.

The inclusion and drafting of MAC clauses depends on the negotiating position of the parties. In general, the buyer may wish to include a MAC clause in the SPA drafted in the most general terms (within the general limitations on the principle of free will set forth in article 1,256 of the Spanish Civil Code), giving him an easy escape route from the transaction upon the occurrence of any circumstance adversely affecting the target company or the market in which it operates. Moreover, if the seller negotiates exceptions (carve outs) to the MAC provisions, the buyer should consider incorporating wording into the SPA that would still trigger the MAC clause if the target company is disproportionately affected. On the contrary, the seller will do its utmost to resist a MAC clause (unless where it was included for its own benefit, e.g. if it receives all or part of the purchase price in shares of the buyer). If the inclusion of a MAC clause in the SPA is accepted, the seller shall procure that those circumstances entitling the buyer to withdraw from the transaction are drafted in the most precise way (even exhaustively); that they include relevancy standards, figures and time limitations; and that the MAC clause is drafted with the highest number of exceptions (carve outs) possible, thus passing the risk to the buyer and ensuring closing the transaction (MAC out). It is common practice that, when determining the risk allocation among the parties during the interim period from signing to closing of the transaction, the buyer assumes systemic-inherent market risks -“market MAC“- and the seller those adverse changes notably affecting the target company -“business MAC“-.

The inclusion of a MAC clause in the SPA implies that the “rebus sic stantibus” rule (which may only be applied by the Courts) is excluded since the courts are not entitled to rule on situations already foreseen and contractually regulated by the parties by virtue of a clause expressly drafted thereto.

In conclusion, MAC clauses can be useful to the parties to regulate the uncertainty inherent to complex transactions as company acquisitions, although their effectiveness and drastic consequences will depend on the accuracy of their drafting.