The novel coronavirus (COVID-19) has already proven to have profound social, political and economic effects on the world, impacting nearly every continent, community and business sector. With the growing uncertainty about the extent to which such effects will be felt in the future, many companies have begun to evaluate their pending acquisition agreements and financing arrangements to consider the scope of terms such as “Material Adverse Change” and “Material Adverse Effect” (MAC), and the provisions using such terms, as they relate to COVID-19.
While merger and acquisition (M&A) agreements and debt financing arrangements typically include MAC provisions, these provisions vary widely and should be read carefully. This article briefly describes some of the things companies should consider in evaluating COVID-19 in the context of MAC provisions in both M&A arrangements and debt financing transactions.
MAC Provisions in M&A Transactions
One area of law where participants may be taking a fresh look at contractual provisions with the effects of COVID-19 in mind is in M&A contracts. In the vast majority of M&A agreements, whether for public or private targets, the buyer will have a “walk right” between signing and closing if the target business suffers a MAC. Regardless of the terminology used and the particulars of the contractual definition, the intent of these provisions is generally understood to allow a buyer that has signed an M&A contract not to have to close if some negative event or circumstance has affected the target business and it is so severe that the buyer’s benefit of the bargain is essentially lost, and the buyer, therefore, has the right to terminate the agreement without closing the acquisition.
Historically, courts in Delaware and other states have treated this as a very high standard—to the point where no Delaware court decision had validated a buyer’s termination of an acquisition agreement based on a MAC until the Delaware Court of Chancery’s Akorn v. Fresenius decision in 2018. However, the facts in that case involved a drastic falloff in performance of the target business that had persisted for over a year, along with several other breaches of the merger agreement from the target side. Subsequent decisions have reaffirmed that the Delaware courts continue to view the MAC standard as a high bar to clear—and that a material adverse effect is a change in circumstances that endures for a protracted period better measured in years than in months or even a few quarters.
Despite the societal and market turmoil and the potentially significant economic effects of the pandemic, a buyer seeking to cite the effects of COVID-19 as the cause of a MAC to get out of an existing purchase agreement may have a difficult time establishing to a Delaware court’s satisfaction the requisite severe and lasting changes on a target needed to satisfy the MAC standard. Both the severity and, in particular, the duration of the crisis are too uncertain for the time being. That could certainly change if the expected downturn is more severe and lasting—particularly in certain industries that are consumer-facing and could see the severest negative effects if customers are advised to stay away for extended periods or if consumer habits are permanently changed. Also, parties that are currently negotiating potential M&A transactions should certainly make a careful examination of the MAC provisions of their agreements to ensure that the intent of the parties concerning the effects of COVID-19 is carefully negotiated and accurately reflected in the agreement’s text.
MAC Provisions in Debt Financing
A MAC provision in a debt financing arrangement has ongoing implications for a borrower that arise, most notably, in three areas:
- The ability to borrow funds under a revolver or delayed draw term loan.
- Required notices to the lenders.
- Events of default.
- Most credit agreements require that to receive extensions of credit under a revolver or delayed draw term loan, the borrower must certify that there has been no MAC since an earlier specified date (usually the date of the most recent audit before the date of the agreement). A borrower must carefully consider whether COVID-19 has resulted in a MAC that would affect the borrower’s ability to make this certification. Some companies, concerned that current and evolving market conditions may impede their ability to access their credit lines, have determined proactively to draw the remaining availability. Every company’s situation is unique, and only time will tell whether such moves were prudent or an overreaction.
- Many credit agreements require borrowers to provide their lenders with notice of certain material events (e.g., litigation, violations of law, releases of hazardous materials on their properties). These notice requirements often include an obligation to give the lenders notice of events or circumstances that could reasonably be expected to result in a MAC, and a failure to provide such notice when required would result in an event of default. Each borrower should examine its credit agreement to determine whether and when a MAC notice may be required based upon the impact of COVID-19 on its particular business.
- Some credit agreements (particularly in middle market and lower middle market transactions) include a MAC provision as an event of default, such that any event that has resulted (or, in some cases, could reasonably be expected to result) in a MAC will trigger an event of default under the credit agreement. If a credit agreement contains a MAC default, the borrower should review the scope and language of the MAC definition and related default provision(s) to be prepared to act proactively in response to COVID-19 developments.
The specific language used in a MAC definition and the related provisions in any given credit agreement significantly affect the analysis in each of these three areas and will be important considerations in evaluating COVID-19 effects on a company’s debt financing arrangements. For example, the inclusion of concepts such as the decline of a company’s future business prospects or its financial performance on a prospective basis, or the effects of market deterioration generally, could have a significant impact on whether the effects of COVID-19 would represent a MAC for a particular company. Borrowers and lenders alike will need to review these provisions carefully and consult with counsel as needed to interpret these definitions and determine how COVID-19 affects a specific company.