Termination of M&A transactions based on MAC clauses
On 1 October 2018, the Delaware Court of Chancery recognised a material adverse change (MAC) clause as a means to terminate a share purchase agreement in the case of Akorn vs. Fresenius Kabi. This text looks at the general significance of MAC clauses, the specific conclusions of the US Court and the practical relevance of the judgment for M&A transactions.
Backdrop and substance of MAC clauses
Company acquisitions can be quite protracted. Many months can pass between the signing of the sale and purchase agreement and closing. During this time, the company to be purchased can undergo radical changes, making the original calculations with respect to the target company invalid. This can be as a result of sudden financial or economic crisis, strong currency fluctuations, changes to key figures, e.g. EBIT or EBITDA, loss of key customers, substantial compliance incidents or other events that have a significant economic effect on the company. The “Material Adverse Change clause” or “MAC clause” (also called “Material Adverse Effect” or “MAE” clause) is designed to allow the purchaser to reconsider or even terminate the agreement in such situations.
A MAC clause functions as a contractual right of rescission pursuant to German law. It is a contractual provision, which (normally) allows the purchaser to withdraw from the contract before closing where there are substantial changes to circumstances.
The reason for such clauses is that, as a rule, a purchaser will have no or only limited influence over the target company before closing, but still has to accept a later worsening of the target’s position – whether due to factors internal or external to the target. This distribution of risk seems unfair and unpractical from the purchaser’s point of view, especially when external financing agreements give investors rights against the purchaser and allow them to cancel the financing agreements (known as back-to-back loans).
A MAC clause, and in particular the circumstances that will allow the purchaser to withdraw from the contract, will differ from case to case and depend on the contractual partners. There is broad consensus that a MAC clause should only relate to circumstances that are beyond the control of the purchaser, as the purchaser would otherwise not need the protection.
In practice, any MAC clause must be clear and must accurately state the cases in which a material adverse event will be accepted. The clause should establish and specify the grounds for a withdrawal from the contract in as much detail as possible and, where viable, these grounds should also be objectively verifiable. Such clauses therefore normally refer to an adverse effect on the assets, financial position or profits or make a link to economic indicators. In addition, the contracting parties often agree to carve
outs, which in turn prohibit the use of the contractually agreed right of rescission in certain circumstances. In our experience, when a contracting party (most often the purchaser) uses a MAC clause, it is not to terminate the contract, but rather to re-negotiate the purchase price.
MAC clause recognised for the first time in Akorn vs. Fresenius Kabi
Until now, there have been few judgments on MAC clauses in the Anglo-American world and in each case the court held that there had been no material adverse effect. German courts are yet to deal with MAC clauses.
The case before the Delaware Court of Chancery of 1 October 2018 concerned the following facts:
In 2017, Fresenius Kabi AG, a German healthcare company, announced that it was going to take over Akorn Inc., a US generic pharmaceutical company. Shortly after signing, Akorn’s financial performance deteriorated significantly, with turnover sinking by 25 % and operating profits by 105 %. These negative developments continued into the first quarter of 2018. In addition, Fresenius received information at the end of 2017 concerning serious breaches of data protection law and issues with Akorn’s compliance with the US Food and Drug Administration regulations.
When Fresenius relied on the agreed MAC clause and refused to close and terminated the sale and purchase agreement in April 2018, Akorn filed a claim for specific performance with the Delaware Court of Chancery.
As the first US court to find that the use of a MAC clause was justified, the Delaware Court of Chancery held that there had been a sufficiently serious adverse change, which would justify Fresenius’ termination of the contract.
As part of its assessment of whether there had been a significant change, the Court analysed the profit-oriented EBITDA figures and compared these with the figures from the same quarter of the previous year. These showed a drop of between 55 % and 62 %. The Court considered this fluctuation sufficiently serious to justify the use of the MAC clause.
The Court found also that the right of termination was not precluded. While the MAC clause in the contract did not allow Fresenius to terminate the agreement when the industry in general was facing difficulties, the Court held that Akorn’s problems were company-specific and, in comparison to competitors, Akorn had faced particularly sharp drop in EBITDA. The material adverse effect in this case was not due to industry-specific factors.
The Court also did not rule out the exercise of the right of termination because Fresenius had gained knowledge of the difficult circumstances as part of its due diligence: the purchaser’s knowledge would only exclude the use of a material adverse effect when this was expressly provided in the contract. There was no
such provision in the agreement between Fresenius and Akorn.
The current judgment is important for future court cases, even if it is not revolutionary. The strict case law of the US Courts was continued in this case and resulted, for the first time, in the acceptance of the exercise of a right of termination on the basis of a MAC clause. The jurisprudence has therefore gained shape.
Moreover, the judgment of the Delaware Court of Chancery significantly refined the requirements of MAC clauses. Even if the Court did not provide a crystal clear definition of a material adverse effect and was careful to avoid specific figures, the judgment provides some guidance on the specific circumstances that
are likely to constitute a material adverse effect.
The judgment also showed that the Courts will use the wording of the MAC clause as orientation. It is therefore recommended that any MAC clause – also outside the US – should be detailed and clear. This is on the one hand an advantage for the purchaser, because it will make it easier to show that the requirements for the use of the MAC clause are met, and establishes the specific findings to use to assess whether there has been a material adverse effect. On the other hand, a clear and detailed MAC clause is also an advantage for the seller, because they can reliably assess whether a claim by the purchaser will have success, as the
seller will be in a somewhat weaker position for the duration of any proceedings.
At least initially, the judgment should have limited effect on German law because situations that would be covered by a MAC clause are already covered under the provisions relating to the disruption of the basic of business (Störung der Geschäftsgrundlage) in section 313 German Civil Code (Bürgerliches Gesetzbuch, BGB). In such cases, the specific wording of the clause will be decisive, as it is in contracts governed by US law.
In light of Brexit, future global economic uncertainties (e.g. the introduction of international duties) and their effect of the finance markets, as well as political uncertainties, we expect MAC clauses
to be discussed and negotiated even more intensively in the future – also in Germany.
Dr Gesine von der Groeben will be happy to answer any questions you may have about this article.
Dr. Gesine von der Groeben