Coronavirus – and the Material Adverse Change Clause

Alarmed by the escalating coronavirus pandemic, corporates and financial institutions such as banks and private equity firms are quietly seeking the advice of their legal counsel on whether they can invoke “act of God” provisions. These include the material adverse change clause (MAC) and force majeure, a legal provision that relieves parties from performing their contractual obligations when certain circumstances beyond their control arise (read more here).

MAC clauses, if successfully invoked, permit a buyer or seller to back out of an acquisition in the event of a material change in the business, operations, or financial conditions of a company.

Acts of God

Lawyers have tried to anticipate ‘God’s wrath’ by crafting contractual clauses that excuse their clients’ obligations if disaster strikes.

Even before the coronavirus pandemic, MAC clauses had become increasingly common in M&A deals, due in part to the increasing complexity of deals and their vulnerability to geopolitical and macroeconomic uncertainty.

MAC clauses are notoriously difficult to enact, with buyers having to prove there has been a sustained decline in a target’s business, rather than simply demonstrating short-term side effects consequent on a one-off event. The terms of contracts can vary widely and the ability to invoke them can come down to the precision of the wording.

Can the COVID-19 pandemic trigger a MAC?

At this point in time, it seems unlikely that a buyer can use material adverse changes resulting from the coronavirus outbreak as a reason to walk away from a deal.  However, this will depend heavily on the specific language in the clause and the facts in each case.

It is common for parties to exclude general economic events, epidemics and pandemics, and other natural disasters from the definition of material adverse change, reflecting the intention that MACs be narrowly interpreted. As the World Health Organization only declared the coronavirus a pandemic on March 11, 2020, it may fall into the category of exceptions to the definition of material adverse change.

Assuming a bank or a corporation did not explicitly exclude an event like the coronavirus pandemic from the definition of material adverse change, it would still be very difficult to use it as the basis for exiting a transaction.

Here’s why:

  • The long-term effects of the coronavirus on most businesses are still unknown, so it would be difficult to convince a court that the coronavirus substantially threatens the overall earning potential of the target company over the long term. Government intervention also complicates matters, as short term relief (loans or purchases of commercial paper) may change the economic position of a company.
  • Even if the pandemic is causing financial distress to the target company right now, and it may be reasonable to expect a downturn in the next several months, most of the current case law requires that the party show that the downturn will be significant over a period of years. China’s lockdown and economic disruption lasted about two months.
  • It seems likely that the other party to the transaction would oppose the use of the MAC clause and open the party trying to use it to costly litigation and, potentially, damages.

Steps you can take now

If you are concerned about how the coronavirus pandemic will affect a potential or current transaction, we recommend the following:

  • Start by reviewing the language in your documents with your legal counsel to determine if there are any specific exclusions to the definition of material adverse change.  Many clauses simply state that a party’s obligations are postponed or excused upon the occurrence of “acts of God or other events beyond the control of” the affected party. However, “acts of God” is a notoriously vague phrase and does not cover many human-made disasters such as war, embargoes, strikes, or cyber-attacks. Is a quarantine imposed by governmental authorities in response to the coronavirus pandemic an “act of God”?
  • Then perform a fact-based examination of how the coronavirus pandemic has impacted the business and how it may affect the target company in the long term.
  • Both parties should be sure to maintain accurate records and data demonstrating the financial impact caused by the coronavirus pandemic.

Coronavirus has had clients scrambling to review provisions in their contracts. While little can be done to change existing language, these clauses should be reviewed each time to ensure they accurately reflect the agreement or transaction being entered into. If you have any questions or would like us to review your standard language, please get in touch with Rooney Nimmo partners Tim Davis (in New York), or Grant Docherty (in Edinburgh), or visit our website here.


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