Original article in Italian published on the legal review Diritto Bancario on March 17 2020 (available at this LINK).
1. Introduction. In M&A contracts, “material adverse change” clauses allow the purchaser to withdraw from contracts should unpredictable circumstances having a material adverse impact occur (“’MAC Clauses”).
2. From the twin towers to the credit crunch. MAC Clauses in international contracts have been of common use since 11 September 2001. One of the most notorious episodes regarding MAC Clauses concerns the case of WPP Group plc vs. Tempus Group plc, a marketing company that launched a public tender offer for the shares of the listed company Tempus Group plc, in the summer of 2001. The tender offer in question contained a MAC Clause which, following the terrorist act, was invoked by WPP Group plc in order to withdraw the tender offer. Later, the 2008 credit crunch resulting from the sub-prime mortgage crisis also witnessed an increase in the use of the MAC Clauses, not just in M&A contracts but also in financing contracts.
3. The impact of Covid-19. Although the 2001 terrorist attack, the credit crunch and the Covid-19 pandemic are very different events, similar economic and social repercussions are expected. Consumer contraction, bank credit crunch, slowed production and import-export problems are among the phenomena leading to a new time of uncertainty also for the M&A sector.
4. Between saying and doing. Sometimes referred to as “Material Adverse Effect” or “Material Adverse Event”, these clauses, born in the M&A contracts practice, have found application in other areas such as financing and project contracts. In particular, their usefulness is evident in any situation where there is a time lag between the moment when the contract is entered into and the moment when it is to be executed.
5. Adverse circumstance. In the contracts practice, an event, effect or change referred to in the MAC Clauses typically concerns the immediate object of the sale or the underlying business/assets and it may address a very specific matter, such as a contract with a particular client, or have a very broad scope, such as the regulatory framework in which the business operates.
6. Exclusions. It is in the seller’s interest to limit the scope of these clauses to the minimum, possibly specifying which categories of circumstances should never be considered for the purposes of the MAC Clause. Since the adverse circumstances must be unpredictable, in order to mitigate the scope of the MAC Clause, the seller may consider disclosing to the buyer any potential risks that could originate such adverse circumstances. On the contrary, it is in the buyer’s interest to define the clause in a way as to secure termination rights should a known risk become concrete.
7. Materiality. The circumstance, as well as adverse, must be material. The seller will do well to define the concept of “materiality”, for example as an impact on business turnover or on other accounting indicators (EBITDA or Net Financial Position), possibly taking into accounts value thresholds. At the same time, the buyer will try to make its own point about the definition of “materiality” or take advantage of vague wording. In this regard, the buyer may attempt to include in the definition of “material circumstance” the abstract propensity to cause adverse effects in the future, while the seller will try to limit its scope to the effects actually occurred before the closing date.
8. Typical remedies. The MAC Clauses typically allow terminating contracts for convenience should an adverse circumstance occur between the date of signing (signing of the preliminary sale contract/framework agreement) and the date of closing (signing of the deed of sale/execution of the relevant obligations). Termination rights may be subject to a cool-off period. Should the adverse circumstance be defined in terms of its impact on accounting indicators, the contracting parties could also provide for a price adjustment mechanism. Should the buyer, instead, impose a very broad MAC Clause, the seller could protect himself by asking for a breakage fee. In order to avoid misuse, the seller could also impose a reasonably short period for the buyer to trigger the MAC Clause.
In the international practice, the absence of material adverse circumstances is sometimes set as a condition precedent, thus making the effects of the preliminary/framework contract dependent on the absence of material adverse circumstances at the date of closing. This use may give rise to practical difficulties in ascertaining whether the condition precedent is fulfilled or not on the closing date.
9. Financing contracts. In financing contracts, material adverse circumstances are those related to the borrower’s ability to fulfill, even if only prospectively, the obligations undertaken under the financing contract. Consequently, the MAC Clauses allow lenders an exit should the borrower’s financial, economic or economic ability be impaired as a result of material adverse events.
10. Market MAC clause. Since the 2008 credit crunch, the Anglo-Saxon practice regarding financing contracts has begun to use the “Market MAC Clause”, a MAC Clause referring not to circumstances relating to the debtor’s ability but to circumstances adversely affecting the broader horizon of the financial markets or interbank credit market. In the context of M&A transactions, the uncertainty arising from the Market MAC Clause in a financing agreement means that such MAC Clause should be back-to-back reflected in the share purchase agreement.
11. Representations & Warranties. Given the time normally taken to negotiate the definition of “material adverse change”, it seems wise to use it also in the context of contractual warranties relating to the conduct of business from the accounting reference date.
12. Italian Civil Code remedies. In the absence of MAC Clauses, the parties to a contract subject to the Italian law can count on the remedies provided by the law in cases of unexpected impossibility or excessive onerousness, pursuant to articles 1463 and 1467 of the Italian Civil Code.
13. Unexpected impossibility. In contracts with reciprocal obligations, the “unexpected impossibility” is an unpredictable event that absolutely and definitively hinders the execution of the obligation by the debtor or the use of such executed obligation by the creditor, provided that this impossibility is not attributable to the creditor and creditor’s interest in having the obligation executed has not vanished yet. Should such an event occur, each party shall be entitled to terminate the contract. A different hypothesis is, instead, a temporary unexpected impossibility: should the event hindering the execution be temporary, the suspension of the execution must be preferred to the termination of the contract: the suspension will then be followed by the termination should the creditor’s interest vanish.
14. Unexpected excessive onerousness. It coincides with the occurrence of extraordinary and unpredictable circumstances making the obligation excessively onerous; such circumstances must also have occurred in the period of time between the entering into of the contract and its execution. As provided for by paragraph 2 of article 1467 of the Italian Civil Code, the termination of the contract shall not be legitimate if the occurrence of onerousness falls within the normal scope of the contract.
15. Wagering contracts. Note that, in the practice of Italian M&A contracts, there is a tendency of qualifying the share purchase agreement as a wagering contract (a contract with a haphazard object) by referring to article 1469 of the Italian Civil Code. Such reference, where appropriately contextualized, could put out of play the application of the excessive onerousness remedies.
16. Change in financial conditions. Finally, pursuant to article 1461 of the Civil Code, each contracting party has the right to suspend the execution of its own obligation should, after the signing of the contract, the financial conditions of the other party put in evident danger the execution of the counter-obligation. Contrary to the unexpected impossibility and excessive onerousness, this provision does not outline a termination remedy but it legitimates the party to activate a form of self-protection should no suitable guarantee be provided by the defaulting party.
17. Conclusion. The uncertain scenario due to the Covid-19 pandemic will give much space to the MAC Clauses. Particular attention will have to be paid to the definition of the “unpredictable circumstances”. In the absence of MAC Clauses, the remedies provided by the Italian Civil Code are available, but they have a limited scope of application.
(c) Giorgio Mariani 2020.