[By Anushree Srivastava & Shravasti Yadav]
The authors are students of Gujarat National Law University.
Introduction
In 2020, LVMH sought to withdraw its $16.2 billion acquisition of Tiffany & Co., citing a Material Adverse Change (“MAC”) and breaches of conditions due to the COVID-19 pandemic’s effect on retail. The dispute ended with a $425 million price reduction, highlighting the influence of such provisions on deal outcomes. MAC clauses are provisions in a contract that allow a buyer in a merger and acquisition (“M&A”) deal to walk away from the transaction if a material adverse event happens to the target company between when the agreement is signed and the transaction is completed. MAC clauses protect a buyer against unexpected detrimental alterations to the business of a target company. However, these provisions in the M&A contract must be read in conjunction with other contractual provisions therein, as they collectively provide for the buyer’s possible grounds for withdrawal. Specifically, those clauses which are similar to MAC clauses, for instance the clauses addressing conditions for execution, backing out and damages in the event of backing out from the contract. It is in light of this that, this blog examines three critical intersections that shape modern MAC clause drafting: its interplay with break fee provisions, bring-down conditions, and the debate between quantifiable versus subjective materiality thresholds.
Indian jurisprudence on the MAC clauses is limited, given that they are rarely litigated and often lead to price renegotiations rather than a termination, which can lead to litigation. However, Delaware courts have continuously refined their interpretation of MAC clauses, making it crucial for M&A practitioners to understand these relationships.
Risk Allocation Mechanism in M&A: Break Fees and MAC Clauses
A Break Fee, or a termination fee, is a penalty paid in M&A transactions if the seller withdraws from the deal, compensating the buyer for the time and resources invested in negotiating the deal. The existence of a break fee and MAC clause in a contract provides the parties with opportunities to develop timing strategies. For instance, buyers may deliberately delay closing of the contract to see if market conditions trigger a MAC (additionally, a MAC claim requires the proof of adverse change over a period of time) while knowing the break fee provides a financial safeguard if their MAC claim is unsuccessful. Conversely, sellers might rush to close the transaction before potential adverse circumstances may materialize, to avoid MAC disputes altogether. It has been observed that MAC clauses are more frequently enforced during periods of high market volatility, as was evidenced during the 2008 financial crisis and the COVID-19 outbreak. Conversely, break fee clauses are typically invoked in stable market conditions. This is so because, in case of market volatility, the buyers face higher uncertainty about the target’s future performance, making MAC clauses more valuable as an “insurance policy” against deterioration. In case the market is stable, break-fee clauses are enforced because there are fewer opportunities to invoke MAC. This reflects the optimal relationship between break fee size and MAC clause scope.
Further, does a more restrictive MAC clause (harder to invoke) correspond with a larger break fee? Usually, a higher break fee is paired with a broader MAC clause, as issues are expected to be addressed under the MAC clause without triggering the fee payment. This higher fee protects against third-party offers and incentivizes sellers to enforce the contract, enabling the buyers to exit without significant penalties during extraordinary events like COVID-19. For instance, in some highly volatile market periods, we’ve seen larger break fees tied to MAC clauses to discourage opportunistic deal abandonment. On the other hand, a reverse break fee is a penalty that a buyer pays if they cannot complete the transaction due to reasons within their control. The inclusion of a reverse break fee with a MAC clause provides buyers a clear monetary framework for evaluating the risk of invoking the MAC clause. This fee acts as a cost of exercising the MAC “option” if market conditions deteriorate, serving as a de facto limit on their deal risk.
Moreover, courts also tend to construe these provisions cumulatively rather than in isolation. For example, some jurisdictions such as the Delaware Courts consider a higher break fee combined with a wide MAC clause as an unconscionable penalty rather than a legitimate liquidated damages provision. In such cases, the MAC clause is viewed merely as an attempt to avoid paying the break fee. This was the case in Sallie Mae Litigation where the purchaser sought to trigger the MAC clause to escape paying higher reverse break fee. Conversely, a broad MAC clause with a low break fee provides buyers more flexibility to exit under adverse conditions.
Risk Management through Intersection of MACs and Bring-Down Conditions
A bring-down condition requires parties to confirm that the representations and warranties in an agreement remain accurate on the closing date. MAC clauses allow buyers to escape unforeseen crises, while bring-down conditions ensure a seller’s representations remain accurate until closing. Their interplay influences negotiations and transaction risks. The standards of evidence to prove a breach of representation differ significantly from those required to establish a MAC, creating a strategic option for buyers: pursue the more specific representation breach or establish the more general but higher-threshold MAC. Courts in different jurisdictions interpret the interaction of these provisions differently. Delaware courts tend to interpret them as complementary but distinct provisions, while some international jurisdictions, such as the England Courts view them as more integrated concepts.
M&A agreements often include a MAC provision to adjust the bring-down conditions regarding its business operations by specifying that nothing material enough to cause a MAC has occurred, thereby establishing a materiality threshold. This is usually done through negative modification or affirmative modification. The MAC clause qualifies a negative statement as “The holding’s records contain no inaccuracies except for those not expected to result in a MAC.” On the other hand, an example of affirmative modification is that “The Holding is not a party to any litigation expected to result in a MAC.” Thus, negative modification enables buyers to focus on material risks while accepting minor discrepancies that do not impact the overall deal. On the other hand, affirmative modification clearly communicates that the seller is aware of potential minor issues but affirms that none are material.
Negative modification uses the “absence of evidence” principle, allowing discretion in managing potential risks without treating them as deal-breakers. In contrast, positive modification relies on “evidence of absence,” providing direct transparency regarding the absence of significant risks. The choice between negative and affirmative modifications in contracts is based on the industry’s risks and business environment. Tech and startup sectors often use negative modification due to their high-risk nature, volatility, and constant changes, which require flexible risk management. On the other hand, mature industries like manufacturing, utilities, and regulated industries (example, healthcare and finance) prefer affirmative modifications, as these industries have stable operations, predictable income, and clear regulations. Furthermore, such contracts often develop highly specific carve-outs for industry-typical litigation (e.g., patent disputes in tech deals, environmental suits in manufacturing) as against unforeseen litigation.
Another issue with using MAC as a bring-down condition is “double materiality,” which occurs when a representation subject to materiality is tested by a MAC condition (itself qualified by materiality). Courts might interpret “material” differently for representations and closing conditions. In simple terms, the same event or fact is judged twice for materiality: once under the representation, and again under the MAC clause. However, the thresholds for what is considered “material” under these two provisions may differ. A Rs. 15,000 penalty, while not “material” enough to breach the representation based on the contract’s explicit threshold, could still be material to a buyer’s willingness to proceed, potentially triggering a MAC provision. This disparity in interpretation can lead to confusion and disputes regarding deal completion. Therefore, in order to resolve this, independent materiality thresholds for representations and bring-down conditions like MAC should be established.
Refining MAC clauses beyond Monetary Thresholds
The determination of the correct threshold for MAC provisions in contracts has become complex, balancing subjective risk considerations and objective monetary thresholds. Practitioners increasingly use measurable financial thresholds to enhance clarity, instead of vague notions like “reasonableness.” However, absolute monetary or reasonable thresholds are not the best alternatives for MAC.
There is increasing utilization of “soft MAC” provisions, which combine quantitative triggers, e.g., a 10% fall in revenue, with a second-level qualitative test. This format requires good-faith renegotiations rather than automatic termination, thus promoting balanced responses. Regulators, like the Australian Securities and Investments Commission (“ASIC”), stress the need for objective and quantifiable criteria for clarity and transparency. Moreover, properly drafted MAC clauses contain carve-outs for general economic or industry-wide conditions. A mere broad economic carve-out is insufficient. Moreover, carefully worded qualification language provides an additional layer of safeguard.
Another effective approach is to define a MAC event as one that disproportionately affects the target company compared to its industry or significantly disrupts the buyer’s strategic basis, thus protecting the transactions from blanket economic changes. This strategy protects purchasers from walking away too easily while still maintaining protection against actual risks. Thus, as opposed to depending on a hard monetary threshold, establishing materiality in relation to particular counterparties provides a flexible solution. For instance, a MAC clause might include an event that would be expected to lower the target’s value below 15% to its top three possible strategic acquirers. This recognizes that materiality varies with the buyer’s goals.
Furthermore, strictly monetary tests face their own issues, such as courts might read such monetary tests differently than MAC clauses, even challenging whether they are consistent with settled jurisprudence of not limiting it to economic difficulty. The settled jurisprudence in SEBI v. Akshya Infrastructure clarifies that a mere decline in financial performance or profitability does not constitute a Material Adverse Change. Courts have emphasized that MAC clauses require a substantial, long-term impact on the target’s business, and cannot be invoked solely based on monetary thresholds or temporary financial setbacks.
Finally, the definition of a “reasonable” threshold percentage is also subject to debate, and without clear legal guidance, parties must ensure that financial benchmarks clarify and do not complicate contracts. The judgment in SEBI v. Akshya Infrastructure has further established that mere financial adversity would not suffice for invoking a MAC, which also raises the issue of whether a pre-negotiated monetary threshold would be distinguished by courts from other financial challenges. In the Energy Watchdog case, the Supreme Court held that performance becoming “onerous” is not enough for contract frustration, indicating that courts would consider monetary tests to be merely an attempt to reframe financial pressure as a condition precedent. These factors underscore the need for a more flexible and context-driven approach to MAC clauses.
Conclusion
The interplay between MAC clauses, break fee provisions, and bring-down conditions determines how buyers and sellers navigate unforeseen events that could jeopardize a transaction. While Delaware courts have set important precedents in interpreting these clauses, Indian jurisprudence remains underdeveloped, often leading to price renegotiations rather than outright litigation. Whether using affirmative or negative adjustments or weighing quantifiable and subjective materiality, the aim is to craft precise yet flexible clauses. In the high-stake arena of M&A, a meticulously crafted MAC clause doesn’t just manage risk; it defines the very boundaries of the deal itself.