Material Adverse Effect (“MAE”) clauses are frequently found in merger and acquisition (“M&A”) agreements. Most typically, MAE clauses are incorporated as a closing condition that permits a buyer to terminate the agreement if the seller has had an MAE between the signing of the agreement and the closing of the transaction. In general, the definition of what constitutes an MAE starts off broad by saying that an MAE is any event or change that is materially adverse to the seller. The parties will then negotiate exclusions from this broad definition.
The spread of COVID-19 has made MAE clauses increasingly relevant. Buyers may be questioning whether the pandemic will trigger an MAE clause and give them a right to walk away from a deal. Ultimately, whether or not a buyer can exercise an MAE right to terminate a deal requires an analysis of the specific language of the M&A agreement. For instance, the MAE definition may exclude changes relating to general economic conditions, which would make it more difficult for a buyer to walk away.
Furthermore, the governing law of the M&A agreement may also play an important role, as some courts have been resistant to find occurrences of MAE absent substantial and durationally significant impacts. For instance, Delaware courts have said that “A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close. A short-term hiccup in earnings should not suffice; rather the MAE should be material when viewed from the longer-term perspective of a reasonable acquiror.” If the economic impacts of COVID-19 continue to be felt over the long-term, a buyer may have a stronger argument that an MAE has occurred.
For buyers and sellers currently negotiating M&A agreements, they should consider the MAE clause in the context of COVID-19 and how they expect the risk of the pandemic to be allocated between the two parties. For example, sellers may seek to specifically identify pandemics as an exclusion to the circumstances which can trigger a MAE. Buyers, on the other hand, may seek to negotiate that the seller should bear the risk of a pandemic if it disproportionately affects the seller as compared to other businesses in the same industry, thereby avoiding a complete pandemic exclusion.