As COVID-19 – commonly known as coronavirus – continues to send shock waves through global markets and industries, dealmakers are considering whether they can terminate, or renegotiate, M&A transactions that they have entered into but have not yet closed by invoking material adverse effect or material adverse change (MAE) clauses.[1]
Understandably, courts have been reluctant to find that MAEs have occurred because of the adverse impact that such findings would have on deal activity. Delaware courts require a MAE finding to be supported by an “adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.”[2] Indeed, the Delaware Court of Chancery has only once held that a buyer suffered a MAE – in Akorn, Inc. v. Fresenius Kabi AG, the Chancery Court found that the buyer validly terminated its merger agreement with the seller because the magnitude of inaccuracies in the seller’s regulatory compliance representations resulted in a MAE. In so finding, the court observed that the MAE must “substantially threaten” the target’s earnings potential for a prolonged period of time.[3]
Of course, a court will first look to the language of the MAE clause in the transaction document. If the MAE clause excludes, for example, pandemics or epidemics, then the buyer will not be permitted to terminate the deal as a result of the coronavirus. However, for deals that are currently being negotiated, in order to avoid any uncertainty, sellers are increasingly adding an express exclusion for the coronavirus and other pandemics.
Even if widespread diseases, such as COVID-19, are not expressly excluded, a MAE clause may contain other applicable exclusions – such as changes generally affecting the economy and changes in conditions that generally affect the industries in which the seller operates – that could limit the buyer’s ability to terminate a transaction. In the absence of an applicable exclusion, as the Delaware courts have indicated, the buyer would still have to demonstrate sustained, material financial detriment to the business. There is a great deal of uncertainty about the coronavirus, but it may be difficult to prove that it will have a long-term and substantial impact on a seller’s business.
MAE clauses are also used in representations that sellers make about their businesses. These representations can be qualified such that, except as would not result in a MAE, the buyer’s business has no risks or deficiencies of various kinds. A court would likely undertake the same analysis as to whether a MAE existed for purposes of determining whether there was a breach of a representation as it would in a situation in which a buyer was exercising its right to terminate the deal. However, as noted above, sellers are increasingly providing for the coronavirus as an express exclusion. Also, carriers that insure representations and warranties (which has become an increasingly popular way of securing claims for breaches) have begun to expressly exclude the coronavirus from their policies. In those deals, buyers are well-advised to make sure that the exclusion is narrowly tailored such that it does not eviscerate the coverage.
[1] For our client alert discussing force majeure clauses in the wake of the coronavirus outbreak, please click here.
[2] See, e.g., Hexion Specialty Chemicals v. Huntsman, 965 A.2d 715, 738 (Del. Ch. 2008).
[3] No. 2018-0300-JTL, 2018 Del. Ch. LEXIS 325 (Ch. Oct. 1, 2018) (quoting In re IBP S’holders Litig. v. Tyson Foods, 789 A.2d 14, 68 (Del. Ch. 2001)).
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