Interpretation of "Material Adverse Change" in the Era of COVID-19
Posted on 04/21/2020 at 12:29 PM by Emily McGovern
The COVID-19 pandemic was a shock to many corporate systems and has changed the reality under which many deals where negotiated and executed. A merger agreement or financing agreement may include a material adverse change ("MAC") provision defining a substantial change in the target or the occurrence of an intervening event, either triggering a party's right to terminate the agreement, releasing a party from certain obligations under the agreement or qualifying certain representations and warranties.
A standard MAC provision includes a general definition of a change, effect, event or conditions that has, or with the passage of time could reasonably be expected to have, a material adverse effect on the target's business, assets or property or upon consummation of the contemplated transaction. Certain events are excluded from this definition: changes in general economic conditions of the target's industry, changes in applicable law, or acts of God (including natural disasters, terrorism or military actions, general economic downturns, etc.). At a high level, systematic risk is allocated the acquirer and risk specific to the target is allocated to the target. As such, the impact of COVID-19 will typically be placed on the acquirer as a systematic risk. However, some agreements will consider disproportionate impact to the target, caused by an excluded event, to be a MAC.
The party asserting a MAC provision has the heavy burden of showing an adverse change material to the agreement as a whole. While some agreements set a dollar threshold for materiality, the analysis of others will be dependent on quantifying the adverse impact to determine materiality. This quantification is typically a function of adverse impact of the target's financial condition/operations and duration. Despite quantification, there is no bright-line rule and a finding of materiality is highly context specific.
The question of whether COVID-19 presents a MAC is a question of contractual interpretation and dependent on the specific circumstances and terms set in the agreement. While MAC provisions are typically interpreted narrowly, the COVID-19 pandemic, and economic impact thereof, is unprecedented. Whether or not the case for a MAC could be successfully argued in court, the COVID-19 pandemic may present argument enough to spur renegotiation of agreement terms or settlement.
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