MAC comeback

Recent decisions of the Delaware Court of Chancery, coupled with extreme market dislocation and a general retreat from the seller's market of 2004-2007, have brought renewed focus on material adverse change clauses in M&A contracts.

Buyers are again requesting MACs that permit them to avoid closing deals when there is a short-term disruption in the target's business, a dynamic that first emerged in 2001 in IBP Inc. v. Tyson Foods Inc. Chancery in that case concluded that only an adverse change, "consequential to the [target's] earnings power over a commercially reasonable period ... measured in years rather than months" could constitute a MAC. In the robust environment of 2004-2007, the Tyson Foods philosophy and seller-favorable conditions combined to reduce, if not eliminate, the efficacy of MACs as a basis for buyers to escape signed deals. Over this period, negotiations produced MAC definitions that included an expanding list of events that could not constitute a MAC.

Against this backdrop came the dispute between Apollo Management LP-backed Hexion Specialty Chemicals Inc. and Huntsman Corp. in September. Hexion attempted to escape a merger agreement with Huntsman by arguing that a deterioration in Huntsman's business between signing and closing amounted to a MAC. The court concluded that because Huntsman had specifically disclaimed any representations regarding projections, the failure to hit its Ebitda targets after signing could not be the basis of a MAC. The court also concluded that the proper way to determine the existence of a MAC is to compare current results against the prior historical period and found only a small decline (3% to 6%) over annual periods. In addition, the increase in net debt had been small (5%) and the Huntsman business units affected by the downturn contributed only 25% of overall Ebitda and, thus, no MAC had occurred. The court held Hexion to its agreement to acquire Huntsman, a transaction that had become unfinanceable, the subject of separate pending litigation.

In response to the current market conditions and to the Delaware Court of Chancery's decisions in this area, some acquirers in private M&A transactions (including private equity firms) have begun once again to push back, harder. These buyers are requesting MAC provisions that would allow them to avoid closing or to renegotiate deals when there is evidence of a short-term disruption in the target's business, specifically rejecting by contractual agreement with the seller the longer-term framework that otherwise applies under Delaware law. For example, recent agreements we have encountered have included modified MACs that specify that adverse changes can be, "either short-term or long-term" or can be viewed "without regard to their duration" and the negotiation over these provisions has been intense. Amid the extreme volatility in today's markets and the lack of access to credit, buyers seeking these provisions may experience more success than in prior years.

As with all contractual provisions, there is no correct position with respect to MAC clauses. From the buyer's perspective, the preference for a short- and long-term-oriented MAC condition is understandable. Buyers and sellers haggle endlessly before signing a deal over adjustments to the target's Ebitda that will serve as the basis for the purchase price. Ultimately, those adjustments translate into multiple-based increases or decreases to the final price, suggesting, at least before a deal is signed, they are material to both the buyer and the seller.

Most buyers would likely say that if they were aware of the types of financial disruptions that occurred in the Tyson Foods and Huntsman cases before signing a deal, they would attempt to renegotiate or walk away.

Conversely, sellers remain appropriately concerned about certainty of execution, particularly once a sale process has narrowed to a single buyer, a transaction is announced and leverage begins to point in the direction of the buyer. MAC clauses in acquisition agreements are also often dependent upon MAC clauses in related financing agreements, a separate topic that is currently evolving.

It is too early to tell whether a significant percentage of buyers will prevail in negotiating for short-term MAC provisions, or whether, if so, the trend will last beyond the current economic crisis. It is also unclear whether the attempt to negate Delaware law standards for MAC clauses by contract will arise in the public company M&A context and how other state courts will rule on the issue. Contractual terms become most relevant in times of extreme market disruption -- these times certainly involve that, and thus continuing and increasing focus on MAC clauses in M&A negotiations is likely to occur.

Michael J. Kendall, John R. LeClaire and James A. Matarese are partners at Goodwin Procter.