31 March 2020
The increasing spread of coronavirus leads not only to considerable consequences for the population and the health system but also to significant effects on the global economy. Productions are reduced or suspended. International supply chains and cross-border logistics are interrupted by border controls or closed borders. Entry bans, restrictions on public assemblies and stricter curfews affect the private sphere as well as the economic activities of companies in the tourism, event and catering industries and the retail business.
Consequently, the parties of transactions are faced with new challenges:
With M&A transactions, the dominating question is to which extent the macroeconomic impact of the coronavirus crisis and the resulting negative development of a target company can jeopardise a transaction’s success. The key objective of any solution should take into account and reconcile the different interests of both purchaser and seller.
While a purchaser will refrain from a proposed transaction if the financial situation of the target company deteriorates substantially and for an unforeseeable period, a seller will pursue to continue the transaction regardless of economic constraints. In case a negative development should become apparent prior to the conclusion of a purchase agreement, a purchaser can break off the negotiations and refrain from the intended transaction.
In order to be entitled to rescind a transaction after the conclusion of a purchase agreement in case of an adverse change in the target company prior to the closing of the transaction, the purchase agreement has to provide for a so-called MAC clause (Material Adverse Change).
However, a seller will only agree to a MAC clause under strict conditions, which, inter alia, should include a contractual penalty. In times of the coronavirus crisis, it is important to reflect these diverging interests of purchaser and seller in the purchase agreement.
A MAC clause provides additional protection to a purchaser in the interim period between the conclusion of the purchase agreement and the closing of the transaction by granting the purchaser the right to rescind the purchase agreement in case of a material adverse change in the target company during the interim period. Negative changes both inside and outside the target company can be included.
MAC clauses generally consist of two components. On the one hand, the parties have to agree on specific MAC events, which can trigger the purchaser’s right of rescission. These are usually military conflicts, natural disasters or other events that can seriously affect a business sector or industry. On the other hand, the parties have to define a materiality threshold, which has to be exceeded in the individual case to determine a material adverse change in the target company.
In the past, MAC clauses have rarely been used in German M&A transactions. Only about 10% to 15% of German purchase agreements contained such a clause while in the USA a MAC clause is included in about 90% to 95% of purchase agreements. The continuing spread of coronavirus is likely to lead to an increasing number of MAC clauses in German purchase agreements.
On rare occasions that a MAC clause has been contractually agreed upon in a German purchase agreement and the transaction has not yet been completed, the purchaser should carefully examine if, and to what extent, the spread of coronavirus and the associated economic consequences for the target company fall within the scope of the MAC clause and grant the purchaser a right of rescission.
If the acquisition of a target company is coming up or if negotiations are currently taking place, it is strongly recommended that the purchaser protects himself against the risks of the coronavirus crisis with a MAC clause. Insofar it is important to formulate the MAC event and the materiality threshold in such a way that both existing and future risks of the coronavirus pandemic are covered as comprehensively as possible.
Regarding the definition of the MAC event, each purchaser should clearly specify the scope in a way to cover the outbreak and spread of a disease. Both coronavirus and the economic consequences should be explicitly included as a separate case in the MAC clause. This is because the concept of a natural disaster does not include pandemics. Pandemics can be of natural origin but they are not natural events.
Similarly, the definition of other events that can seriously affect a business sector or industry is too broad. Due to the scope of interpretation, there is a risk that the purchaser's right of rescission might be excluded in an individual case as it remains unclear which objective criteria determine the impact on a business sector or industry.
In contrast, a seller should always try to define a narrow scope of the MAC clause and limit it to company-related events to exclude uncontrollable events outside the target company.
Two criteria have to be taken into account to determine the materiality threshold for the incurred damage.
First, the factual scope of the damaging event is decisive. A purchaser should always relate the materiality threshold for the incurred damage to the relevant business sector or industry and not limit the materiality threshold to the target company. This will grant the purchaser a right of rescission if the profit or turnover figures in the relevant business sector or industry are declining overall.
It will therefore be irrelevant whether the coronavirus pandemic actually affects the target company or will only affect it later. A seller, on the contrary, should always ensure that the nature of the incurred damage is determined solely by the concrete figures of the target company. Only this approach can ensure that general economic developments do not have any negative effects on the intended transaction.
Second, the temporal scope of the incurred damage is significant. A purchaser should always try to include foreseeable future losses – ie losses that do not occur until after the transaction has been completed – in the determination of materiality. Thus, a purchaser-friendly wording should take into account the need for an adverse adjustment or change to the business plan of the target company, for example.
In contrast, a seller should always try to exclude all future losses to ensure that the purchaser will not be entitled to rescind the purchase agreement based on prognoses but only on losses that have actually and demonstrably occurred prior to the closing of the transaction.
A well-balanced MAC clause could be drafted as follows:
MAC shall mean any event, circumstance or development that occurs between the Signing Date and the Closing Date and which, alone or in combination with other events, circumstances or developments, has a material adverse effect either on the Company's annual EBITDA in excess of EUR [___] or on the Company's assets in excess of EUR [___], except for (a) general economic and market developments in the markets and market segments served by the Company and affecting the industry as a whole (eg general developments in the markets of the Company and/or in the capital and financial markets in general or in exchange rates), but excluding any developments attributable to coronavirus, (b) any adverse effects of losses, damages, costs or liabilities for which the Seller has indemnified the Purchaser, (c) changes in laws or other legal provisions, and (d) circumstances for which the Purchaser is responsible.
Especially in uncertain times of the coronavirus crisis, a MAC clause results in the substantial risk for the seller that the transaction will fail after the conclusion of the purchase agreement due to a rescission by the purchaser. Thus, a seller should always pursue to link and secure a MAC clause with a penalty at the purchaser's expense for exercising the right of rescission. The amount of the contractual penalty should be so significant to prevent the purchaser from making hasty use of the right of rescission and, in any case, fully cover the expenses incurred by the seller in connection with the transaction.
In times of the coronavirus pandemic, the parties of a transaction should not limit the preventive measures to negotiating a MAC clause but should also carry out supplementary reviews of the target company and include other supporting provisions in the purchase agreement.
For example, depending on the progress of the transaction, each purchaser should, as part of the due diligence process, enquire about measures already taken to limit or prevent the effects of the coronavirus crisis to ensure that the target company has adequate crisis management in place. In addition, the catalogue of guarantees and indemnities should be extended to include crisis-relevant issues in individual cases.
In contrast, each seller should ensure to remain fully capable of taking special actions to manage the crisis in the interim period between the conclusion of the purchase agreement and the closing of the transaction. For this purpose, special exceptions to the obligation to continue the business of the target company in the ordinary course of business should be contractually agreed upon.
The uncertainties of the coronavirus pandemic confront parties of M&A transaction with new challenges. MAC clauses with a wide scope can protect purchasers from serious economic changes in the target company even after the conclusion of a purchase agreement. Sellers, by contrast, are confronted with the risk of failure of the transaction and should avoid MAC clauses or at least protect themselves against a hasty rescission of the purchaser by severe contractual penalties.
In these economically difficult times, we support both purchasers and sellers not only in the examination of existing MAC clauses in already concluded purchase agreements but also in negotiating and drafting MAC clauses in upcoming M&A transactions.
We're happy to answer any questions you may have and to examine your options for action. For more comprehensive information and recommendations, see our dedicated webpage on the legal implications arising out of the coronavirus pandemic.