Businesses in Ireland and around the world are reeling from the sudden and unexpected impact of the COVID-19 pandemic.
As a result of market volatility and uncertainty across the globe, M&A activity has slowed down, with many transactions, particularly those in the hardest-hit sectors such as travel, tourism, hospitality and leisure, having been aborted or paused.
But what about those pending transactions where agreements have already been signed but completion is yet to occur?
Inevitably, parties to pending transactions will be turning to their acquisition agreements to review their contractual rights and obligations, weigh up their risks and assess their options. In particular, many buyers who successfully negotiated a “material adverse change” or “MAC” condition to completion may now be considering their rights to terminate or renegotiate. Equally, many sellers may be considering how to respond to a notice received from a buyer alleging that a MAC has occurred.
In every M&A transaction in which an acquisition agreement is to be signed subject to the satisfaction of one or more positive conditions (eg a regulatory or third party consent), there is a balance to be struck between deal certainty for the seller and assurance for the buyer that, during the period between signature and completion, the fundamental deal will not materially change. A MAC condition is one of the principal methods by which buyers and sellers allocate amongst themselves the risk of an adverse effect on the target business (including general market risk) between signature and completion.
In its simplest form, a MAC condition gives a buyer the right to bring the acquisition agreement to an end in the event of a material adverse change to the target business between signing and completion. However, the negotiation of a MAC condition is typically highly contentious, complex and deal-specific. The parties’ respective bargaining strengths ultimately determine the scope and detail of any MAC condition.
Can COVID-19 trigger a MAC condition?
Whether a buyer can invoke a MAC condition to terminate an acquisition agreement on the basis of the impact of COVID-19 largely depends on the form and content of the relevant provision and the extent of the effect on the target business.
As a general rule, the more specific the MAC condition, in particular as to the triggers which will allow the buyer to invoke the provision (eg a defined loss of revenue; a reduction in net asset value of a certain level; or the loss of specific contracts), the more likely it is to be enforceable. Therefore, where parties have expressly identified what constitutes a “material adverse change” in the context of the particular deal (and/or set out express carve-outs from the MAC definition), they will now have a far greater degree of certainty as to their rights and obligations under the MAC condition during the COVID-19 crisis.
Whether a buyer can rely on a more generic MAC condition (eg referring simply to an unspecified material adverse change to the business or net asset value or financial condition of the target business) to avoid completion during the COVID-19 crisis remains unclear. There is very little guidance available from the Irish courts to date on MAC conditions.
Guidance can be gleaned from the approaches of the US and UK courts which focus on factors such as the following:
(i) The information available to the buyer at the time of signature: Given the rapid pace at which COVID-19 has spread throughout the world and the constantly evolving nature of the crisis, it is difficult to determine at which point it could be said that a buyer was aware that the virus might lead to a deterioration in the business of the target company. However, the foreseeability of the crisis from the buyer’s perspective may be relevant depending on the date of signature.
(ii) The likely duration of the material adverse effect on the target business: If the adverse effect to the target business is temporary and involves only a short-term impact on earnings, it may be determined that the material adverse change is not of such significance as would justify termination. On the other hand, where COVID-19 has an impact which is likely to be of a more long-term and lasting nature, the MAC condition is more likely to be enforceable.
(iii) Any disproportionate impact on the target business as compared with other businesses in the industry: The global reach of COVID-19 may make it difficult for a buyer to argue that a target business has been impacted to a greater degree than its industry peers but each particular case will turn on its own specific facts.
Ultimately, whether a MAC condition can be invoked will come down to the form of wording agreed between the parties. The acquisition agreement and MAC clause should be carefully reviewed and the actual effect of COVID-19 on the particular business considered in detail.
A definitive conclusion as to the enforceability of a MAC clause on the basis of COVID-19 is difficult, particularly in the absence of clear guidance on the construction of MAC conditions from the Irish courts. We may see cases before the courts on MAC conditions in the near future arising from pending transactions impacted by COVID-19. However, both buyers and sellers, when faced with the uncertain outcome of litigation (and the consequential cost and delay), may instead be open to renegotiation of the terms of the deal and, perhaps, some risk-sharing on the impact of COVID-19.