A Material Adverse Change (MAC), also known as Material Adverse Event (MAE), clause enables a party to withdraw from a contract in circumstances where there is a material change after its signing. Such clauses are usually found in acquisition and financing agreements. In acquisition agreements, the MAC clause gives the buyer the option of withdrawing from the transaction whereas in financing agreements, it gives the lender the option of not disbursing the amount agreed to be advanced.

MAC clauses are essentially definitions that reflect the allocation of risks between contracting parties. The risks allocated to the seller or borrower (as appropriate) are covered by the MAC clause whereas all other risks are allocated to the buyer or lender, respectively. Generally, systemic and industry-wide risks are allocated to the buyer/ lender while risks that are specific to the business/ borrower are allocated to the seller/ borrower. The MAC clause is used in conjunction with other provisions of an agreement. For instance, in acquisition agreements, the absence of any MAC could be a condition precedent for closing or a representation/ warranty by the seller. Additionally, the occurrence of a MAC could also be a ground for termination by the buyer. Similarly, in financing agreements, the absence of any MAC could be a condition precedent to drawdown/ disbursement under a facility or a representation/ warranty by the borrower. At the same time, the occurrence of a MAC could also be an event of default entitling the lender to accelerate/ recall the loan.

Change in Attributes of the Target/ Borrower

In order to trigger a MAC, a change must relate to one or more of the specific attributes of the target/ borrower mentioned in the MAC clause. These attributes include financial condition, business, assets, etc. Having fewer attributes in the MAC clause can considerably narrow down its scope. For instance, the Federal Court of Australia has held that a change in cash flow projections did not constitute a change in the ‘business, assets or financial condition’ of the borrower.[1] Inclusion of a longer list of attributes such as condition (financial or otherwise), business, assets, operations, etc. may reduce the risk of changes being found not to be covered under the MAC clause. The specific attributes that should be included will vary depending upon the circumstances in which the agreement is being signed as well as the business model of the target/ borrower.

Further, the change needs to be determined by reference to the circumstances that existed at the time the agreement was signed. The Court of Chancery at Delaware (United States) has held that even where a MAC clause is broadly written, it is best read as a backstop protecting the acquirer from the occurrence of ‘unknown’ events,[2] thereby suggesting that MAC cannot be invoked if a change is caused by an event which was known at the time the agreement was signed. However, the Queen’s Bench Division (England) has held that mere knowledge of the acquirer of the causes of probable future losses prior to the agreement would not prevent the acquirer from invoking a MAC if such losses actually occur because it is concerned with changes and not with the causes of such changes.[3] Ordinarily, a party cannot invoke the MAC clause on the basis of circumstances of which it was aware at the time the agreement was signed since it will be assumed that the parties contracted despite the same. However, it will be possible to invoke the clause where conditions worsen in a way that makes them materially different in nature.[4]

Anticipated changes/ effects

A MAC can usually be invoked only in respect of circumstances that exist on the date of invocation. However, specific wording may enable a MAC to be invoked in respect of anticipated changes as well. For instance, where (i) the seller represented that there was no threatened litigation other than those that “… would not have or reasonably be expected to have …” a MAE; and (ii) ‘prospects’ was one of the attributes mentioned in the MAE clause, the court relied on the same to observe that the said clause emphasises the need for a forward-looking analysis which would include changes reasonably expected to occur in future.[5] Nevertheless, even if a MAC clause included such wording, the likelihood of the anticipated change/ effect must be clearly demonstrable when invoked. The Supreme Court of New South Wales (Australia) has indicated that the anticipated change/ effect should be so likely that any objection as to MAC not having already occurred should be “… tantamount to a submission that a person who falls out of an aircraft has not suffered a [MAC] until the person hits the ground…”.[6]

Determining Materiality

Every adverse change does not amount to a MAC; only ‘material’ changes do. If the MAC clause prescribes a formula or method for what is material, then the issue of materiality will depend on the said formula/ method. If no formula/ method is prescribed, then it will be left to the court to determine whether the particular change(s) in question are material based on judicially formulated principles. Courts in Delaware (United States) have evolved the following principles for determining materiality in MAC clauses in the specific context of acquisition agreements:

• Contractual language has to be read in the larger context of the transaction to determine what is material;[7]
• Even where a MAC condition is broadly worded, the same is best read as a backstop protecting the buyer from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally significant manner;[8]
• A short-term hiccup in earnings should not suffice, rather the MAC should be material when viewed from a long-term perspective of a reasonable acquirer;[9]
• The most important consideration is whether there has been an adverse change in the target’s business that is consequential to the target’s long term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months;[10] and
• The issue of whether a change/ effect constitutes a MAC has both qualitative aspects and quantitative aspects.[11]

In the context of financing agreements, courts have held that only a change which significantly affects the borrower’s ability to perform its obligations and, in particular, its ability to repay the loan will be considered material.[12] 

Proving the Existence of a MAC

Unless there is clear language to the contrary, the burden of proving the occurrence of a MAC/ MAE is on the party seeking to excuse its performance, irrespective of how the MAC/ MAE is drafted (i.e. whether as a representation/ warranty or as a condition precedent).[13] In acquisition agreements, the burden is a heavy one for the buyer to discharge.[14] Mere speculation is not enough and both factual as well as expert testimony is required to be adduced in order to discharge this burden.[15] However, admissions made by the seller/ borrower during the course of the trial may sometimes be sufficient by themselves for the court to rule in favour of the invoking party.[16] 

Subjective MAC Clauses in Financing Agreements

Sometimes, MAC clauses in financing agreements provide that the issue of whether a MAC. has occurred will be determined in the opinion or reasonable opinion of the lender. In such cases, the question which the court has to examine is not whether a MAC has in fact occurred but whether the lender has properly formed the required opinion.[17] Where the MAC clause requires the formation of a reasonable opinion, the likely approach is for the court to apply principles akin to those laid down in the context of judicial review of administrative action[18] and only satisfy itself that the lender has not acted arbitrarily, capriciously, whimsically or dishonestly without substituting the lender’s opinion with the court’s own judgment regarding whether a MAC has occurred. Where the clause merely requires the formation of an opinion, the court will only ascertain if the opinion formed by the lender was an honest one.[19] The Supreme Court of New South Wales (Australia) explained this to mean that the opinion of the lender will be upheld unless it is so perverse/ irrational that no reasonable person in the position of the lender could have formed that opinion.[20] However, even in such cases, it cannot be ruled out that the courts may imply a term to the effect that any opinion formed by the lender regarding occurrence of a MAC must necessarily be a reasonable one.[21] 

MAC and Covid-19 in the Indian context

The above examination of the judicial approach across various jurisdictions indicates that the courts are conservative when viewing MAC clauses and do not readily permit parties to use MAC for terminating an agreement. While Indian courts have not yet had the opportunity to rule on a MAC clause, there are indications they will be equally (if not more) circumspect when dealing with it. First, the Supreme Court has, in the context of the Takeover Code, interpreted the grounds on which an open offer may be withdrawn in a very narrow manner that is akin to impossibility.[22] Secondly, Indian courts are likely to approach MAC clauses as being a contractual avatar of the doctrine of frustration and apply the high thresholds under Section 56 of the Indian Contract Act, 1872 while determining the justification for invoking such a clause.

Given that the Covid-19 situation is widely perceived as a temporary one, parties invoking MAC based on the pandemic will have to demonstrate that its effects on the specific target/ borrower in their case are so grave that they will continue well after the crisis has been resolved. This may be difficult at present because the duration of Covid-19 itself is still unknown and ascertaining its full economic impact is, therefore, even more difficult. However, there could be cases where the severity of the impact would be sufficient to demonstrate a MAC. Parties invoking MAC even in such cases should anticipate being dragged into litigation and prepare for the same by collecting sufficient material to defend their invocation. In cases where the impact has not yet occurred but is unmistakably imminent, parties invoking MAC should consider the timing of invocation carefully and be aware of heightened litigation risks. Where agreements have been signed after the Covid-19 outbreak, parties invoking MAC should be prepared to demonstrate that the extent of its adverse impact on the target/ borrower has been so significant that it could not have been foreseen/ contemplated by the parties at the time of signing the agreement.

Concluding Observations

MAC clauses came about, at least in part, as an alternative to invoking force majeure and frustration. The purpose was to include an option with a somewhat lower threshold to make it easier for a party to walk away from a transaction. However, given the judicially evolved principles for interpreting a MAC clause, parties will find that invoking it comes with its own set of challenges. Even if a MAC clause is tailor-made for the specific transaction in question (as is best practice), the evidentiary burden on the invoking party coupled with the cost of collating sufficient material to discharge the same could be daunting. In the context of acquisition agreements, invoking a MAC is likely to remain an option on paper and do little more than provide leverage to re-negotiate the terms of the agreement since most sellers would prefer to avoid a protracted litigation. However, in the context of financing agreements, if the lender invokes an event of default based on MAC, it could effectively trigger the slide of the borrower into insolvency, leaving him with no option but to drag the lender into litigation as a survival strategy.

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[1] Canberra Advance Bank Ltd. v. Benny, (1992) 115 ALR 207.

[2] In Re IBP Inc., Shareholders Litigation, 789 A.2d 14 (Del. Ch. 2001), at 68.

[3] Levison v. Farin, [1978] 2 All ER 1149, at 1156.

[4] Grupo Hotelero Urvasco SA v. Carey Value Added SL & Anr., [2013] EWHC 1039, at Pg. 60 Para 362; Inmet Mining Corp. v. Homestake Canada Inc., [2002] BCSC 61, at Pg. 17 Para 128; Cariboo Redi-Mix & Contracting Ltd. v. Barcelo, 1991 CarswellBC 2263; Capitol Justice LLC v. Wachovia Bank NA, 706 F.Supp.2d 23 (2009), at 30.

[5] Frontier Oil Corpn. v. Holly Corpn., 2005 WL 1039027.

[6] Minumbra Lancewood Pty Ltd. v. AM Lancewood Investment Nominees Pty Ltd., [2013] NSWSC 1929.

[7] In Re IBP Inc., Shareholders Litigation, 789 A.2d 14 (Del. Ch. 2001), at 67.

[8] In Re IBP Inc., Shareholders Litigation, 789 A.2d 14 (Del. Ch. 2001), at 68.

[9] In Re IBP Inc., Shareholders Litigation, 789 A.2d 14 (Del. Ch. 2001), at 67.

[10] Akorn Inc. v. Fresenius Kabi AG & Ors., 2018 WL 4719347, at Pg. 34, affirmed by Supreme Court of Delaware in 198 A.3d 724 (2018).

[11] Akorn Inc. v. Fresenius Kabi AG & Ors., 2018 WL 4719347, at Pg. 43; Frontier Oil Corpn. v. Holly Corpn., 2005 WL 1039027, at Pg. 29.

[12] Grupo Hotelero Urvasco SA v. Carey Value Added SL & Anr., [2013] EWHC 1039, at Pg. 59 Para 357.

[13] Frontier Oil Corpn. v. Holly Corpn., 2005 WL 1039027, at Pgs. 27-28; Hexion Specialty Chemicals Inc. & Ors. v. Huntsman Corp., 965 A.2d 715 (2008), at 739-740; Capitol Justice LLC v. Wachovia Bank NA, 706 F.Supp.2d 23 (2009), at 29.

[14] Hexion Specialty Chemicals Inc. & Ors. v. Huntsman Corp., 965 A.2d 715 (2008), at 738.

[15] Frontier Oil Corpn. v. Holly Corpn., 2005 WL 1039027, at Pg. 28.

[16] This was done by the High Court of Singapore in Van Der Horst Engineering Pte Ltd. v. Rotol Singapore Ltd., [2006] SGHC 53.

[17] Canberra Advance Bank Ltd. v. Benny, (1992) 115 ALR 207; Cukurova Finance International Ltd. & Anr. v. Alfa Telecom Turkey Ltd., [2013] UKPC 2.

[18] See Associated Provincial Picture Houses Ltd. v. Wednesbury Corpn., [1948] 1 KB 223.

[19] Vision Telecommunications Pty Ltd. v. Australia & New Zealand Banking Group Ltd., [2001] WASC 139.

[20] Minumbra Lancewood Pty Ltd. v. AM Lancewood Investment Nominees Pty Ltd., [2013] NSWSC 1929.

[21] For the principles regarding when terms can be implied in a contract, see Attorney General of Belize v. Belize Telecom Ltd & Anr., [2009] 1 WLR 1988; Nabha Power Ltd. v. Punjab State Power Corpn. Ltd., (2018) 11 SCC 508.

[22] Nirma Industries Ltd. & Ors. v. SEBI, (2013) 8 SCC 20.