The threat of terrorism and its potential impact on companies should always be considered when negotiating M&A transactions in any country or environment.
Acquirers are sometimes attracted to targets operating in volatile and hostile regions, as the risky environment can drive down valuations or share prices to create attractive investment opportunities. An extreme example would be an acquisition of an oil company operating in the Kurdistan region in Iraq, which is an extremely volatile region given its location along the path of the ISIS conflict. The risks of terrorism and other political and security factors would undoubtedly play a central role in the negotiation and pricing of any such deal.
However, recent attacks at the Charlie Hebdo office in Paris and the Bardo Museum in Tunis remind us that terrorism can impact people and companies anywhere in the world. Terrorism can result in financial loss to companies both as a result of general market movement and, more catastrophically, from direct attacks on the company. On the day that markets reopened after the September 11, 2001 attacks, United Airlines experienced a 42% decline in its stock price. Also, according to a study of 75 terrorist attacks between 1995 and 2002 involving publicly traded targets, the average loss per firm per attack was USD$401 million in firm market capitalization.
In the context of an M&A transaction, the impact of a terrorist attack on a target can render a proposed merger or acquisition unviable. The negotiated price may no longer accurately reflect the value of the target business after the attack, and companies should always take this risk into consideration when negotiating a deal. In some circumstances where the risk is an inherent part of the target’s operations, the risk can be factored into the purchase price as a discount. Alternatively, companies can employ a “material adverse effect” (MAE) clause in the acquisition agreement to permit a party to walk away from a deal if there has been an MAE on the target company between the signing of the deal and the closing date.
MAE clauses are very common. According to the ABA’s 2014 Canadian Private Target M&A Deal Points Study, of 60 acquisition agreements considered, 88% of the agreements included an MAE clause. However, 83% of these MAE clauses included carve outs for general changes to the economy or applicable industry, with 55% specifically carving out the ability to walk away from the deal in the event of an MAE related to war or terrorism.
Even if an MAE clause includes a terrorism carve out, protection against the risk of terrorism can be provided by including a “disproportionate effect” qualifier so that the MAE clause can still be invoked if an act of terrorism affects the target in a disproportionate manner. For example, with a disproportionate effect qualifier an acquirer may be able to invoke the MAE clause and walk away from a deal if terrorists directly attack the target, despite the fact that the attack may also affect the economy in general. According to the ABA study, 53% of defined MAE clauses provide a disproportionate effect qualifier for at least one carve out.
The exact scope of an MAE clause is ultimately a function of negotiations between the parties and the unique risks each of them face. Nevertheless, no matter the remoteness of terrorism threats to a target, acquirers should always consider this risk and negotiate or price their deals accordingly.
The author would like to thank Matthew Lau, articling student, for his assistance in preparing this legal update.