Oil prices have plunged by about one-third in the past 90 days and this past week oil fell for five consecutive days and dropped approximately 10 percent for the week. While many think that prices are at the bottom, others are of the opinion that further losses are possible. In September 2015, Goldman Sachs cautioned that oil could fall to $20 a barrel if if the Organization of Petroleum Exporting Countries (OPEC) production levels persist1. At that time, West Texas Intermediate (WTI) was hovering in the high 40s and many dismissed this idea. However, with WTI closing out last week at $33.16, $20 oil does not seem implausible especially because although OPEC production slipped a bit in December, it still remains near record highs2.
Downward prices have continued to stress producers and as they run out of runway, more will inevitably consider strategic mergers and divestitures in an effort to stay afloat. As such activity picks up in the coming months, potential buyers would be remiss if they do not revisit a provision in purchase and sale agreements that had become formulaic before the oil prices sharply declined.
The material adverse effect (MAE) clause allocates risk between a buyer and seller. If a qualifying adverse event occurs, then the buyer has the option to “walk” the deal. However, the problem is that this is a tremendously difficult argument to make and, in the now well-known Huntsman vs. Hexion opinion, Chancellor Stephen Lamb of the Delaware Court of Chancery noted that no Delaware court had ever sided with a buyer on an MAE claim. While the more recent Osram Sylvania vs. Townsend Ventures, LLC decision, in which the Court of Chancery determined that the seller’s failure to meet sales forecasts may lead to an MAE, suggests a potential shift in this position, buyers should look at MAE provisions more closely in the current volatile environment.
Among other things, a typical MAE clause is vaguely defined (e.g., “any circumstance, change or effect that is materially adverse to the business, operations, assets or financial condition”) and contains exceptions (e.g., changes in general industry conditions and commodity prices) that are not intended to constitute an MAE. Establishing a more precise and objective standard and eliminating or modifying pertinent exceptions could give the buyer some much needed flexibility with respect to events that occur between signing and closing that cause it to rethink the deal. While it is unlikely that buyers will be able to negotiate a bulletproof MAE walk right, perceptive buyers with leverage can certainly protect themselves better by making targeted modifications to the one-size-fits-all MAE clause that has become an industry norm.
1 http://fortune.com/2015/11/23/oil-prices-20-barrel.
2 http://finance.yahoo.com/news/opec-december-oil-output-slips-143648570.html.
